What is Annuity in Advance
Annuity in advance refers to an amount of money that is regularly paid at the beginning of a term. Rent is the classic example of an annuity in advance for a landlord because it is a sum of money paid at the beginning of the month to cover the period to follow. An annuity in advance, a legal and accounting term, is also called an "annuity due."
BREAKING DOWN Annuity in Advance
Annuity in advance has nothing to do with the financial or insurance product "annuity" despite the use of the word. Another way to describe an annuity in advance is a series of equal payments that are received at the beginning of each equally spaced period. The payment is made before a service is rendered or a good changes hands, so no interest is applied. It also means that the present value of an annuity in advance is higher than payments made later, such as after a service is provided or goods change hands.
There are three elements of an annuity in advance or an annuity due:
- Each payment is in the same amount (for example, a series of $100 payments)
- Each and every payment is made at the same time interval (such as monthly, quarterly or annually)
- Each and every payment is made at the beginning of the specified time period (for example, a payment made on the first day of each month)
Annuity in Advance vs. Annuity in Arrears
The opposite of an annuity in advance is an annuity in arrears (also called an "ordinary annuity"). Mortgage payments are an example of an annuity in arrears, as they are regular, identical cash payments made at the end of equal time intervals. Like rent payments, mortgage payments are due on the first of the month. However, the mortgage payment covers the previous month's interest and principal on the mortgage loan.
One instance where the difference between an annuity in advance and an annuity in arrears matters is in the valuation of income properties. If payments are received at the beginning of the rental period rather than at the end of the rental period, the present value of those payments increases.
Mathematical formulas for figuring the present and future values of an annuity in advance or an ordinary annuity can be found here.
Since most payments are made at the end of a period rather than at the beginning, the annuity in advance (annuity due) concept is less frequently employed compared to the annuity in arrears (ordinary annuity) concept.
Annuity in Advance Example
In addition to rent as the most common example of an annuity in advance, there are leases. For example, assume that a company contracted for use of a piece of hardware via a lease that required a regular payment of $1,000 at the beginning of every month for five years. Such an agreement would amount to an annuity in advance since each payment is equal, and is made at the start of each uniform interval.