Decreasing Utility Contract Interest through Annual Payments

Federal agencies can leverage annual payments to get the best value from utility energy service contracts by decreasing total interest paid.

Annual payments allow Federal agencies to pay for an entire fiscal year (12 months) of payments in advance. This method is attractive to finance companies and may also fit Federal budget and funding constraints, saving a substantial amount of interest expense. Savings are generated because financing is amortized faster and less interest accrues over the term of the project funding.

It is important to note that the interest rate used for a monthly amortization is lower than that used for an annual amortization (mathematically known as the bond equivalent yield). However, even with the slightly increased interest rate, interest payments over the payment period are less than monthly payments. The net effect is that total interest payments decrease, depending on the term, by 8% to 14%.

In some cases, finance companies prefer that the annual payment be made on December 1 so they are assured that the agency will have received its annual appropriation.

The two examples below show approximate savings for different amounts and contract periods.

Example 1
Finance term   120 months (10 years)
Project amount   $10 million
Monthly interest rate   8%
Monthly payment   $121,327/month
Annual interest rate   8.3%
Annual payment   $1,394,758/year
Total monthly payments   $14,559,310
Total annual payments   $13,947580
Savings from annual payment   $611,730
Interest savings   13.5%
 
Example 2
Finance term   240 months (20 years)
Project amount   $20 million
Monthly interest rate   8%
Monthly payment   $167,288/month
Annual interest rate   8.3%
Annual payment   $1,923,112/year
Total monthly payments   $40,149,122
Total annual payments   $38,462,252
Savings from annual payment   $1,686,870
Interest savings   8.3%