An ordinary annuity is a series of payments that are made periodically, at the end of a period such as a month or a year. An ordinary annuity is usually paid over a fixed period of time. A mortgage with a fixed mortgage rate is an example of an ordinary annuity, as is a bond with straight coupon payments.
An ordinary annuity is sometimes called an annuity in arrears. This name is used because the payments are made at the end of the monthly or annual period rather than at the beginning. If payments were made at the beginning of the term, the contract would be called an annuity in advance, or an annuity due. Annuity payments can also be made quarterly or semi-annually. Bond payments are often made semi-annually.
The amount of the monthly payment or yearly payment from an ordinary annuity is calculated from the principal balance and the term of the annuity. The interest rate and the future value of the annuity are also factored in. The future value provides the total cost of the loan, in the case of a mortgage, or the total return on investment, in the case of a bond. These factors determine the amount of the periodic payment, which is typically fixed over the term of the annuity.
An ordinary annuity is sometimes referred to as an immediate annuity. An annuity-immediate is an annuity that has a single purchase payment, rather than multiple purchase payments over time. Annuity payments begin immediately upon the purchase of the annuity contract. In the case of a mortgage, the lender provides the principal amount, and the payments begin at the end of the first full month following the closing. In the case of a bond, the investor purchases the bond and coupon payments begin after six months and continue for the duration of the bond.
An annuity can also be used to provide a regular stream of income for people in retirement. These annuities usually do not have a fixed period of time over which they pay, but rather, the payments will continue as long as the annuitant lives. There may be a minimum period of time for which payments are made, but they continue for at least as long as the person, or, in some cases, a married couple, lives. In this case, the age of the annuitant(s) is also considered when calculating the payments.
