In most cases, the purchase of a property is associated with a high purchase price. This is likely to be in the six-figure range, which is why long-term real estate financing is used. Short-term consumer loans are out of the question for such a loan amount, as long-term financing has significantly better conditions.
But what financing options are there and what makes them different? In this article, we answer important questions about home loan and savings contracts, loans, mortgages and state subsidies. You can find more tips to help you choose the right loan in this detailed article to read.
Private real estate financing - the basics
In principle, real estate is paid for to a certain extent from saved equity. This is supplemented by borrowed capital, which is obtained via loans, as well as securities that can be liquidated. In addition to borrowed capital in the form of a loan, an employee savings allowance, a state subsidy, a KfW Bank subsidy program or a Wohn-Riester scheme can also be used.
A loan usually comes from a building society, an insurance company, a bank or a state development institute. Only very rarely is the future owner of the property offered a loan from a well-known private individual or their employer. The Internet is becoming an increasingly attractive sales channel for taking out a loan.
The lender wants to ensure that a loan is actually paid off. This is why a land charge or mortgage is recorded in the local authority’s land register. New consumer protection laws came into force in 2008. They stipulate that the contract for a loan can only be terminated by the lender if the installment arrears amount to at least 2.5 percent of the total loan amount. If such a default occurs, the credit institution is entitled to present the property at a forced sale. However, because this can result in losses, as foreclosures usually do not achieve the real value of the property, the bank reserves the right to demand further collateral.
The difference between owner-occupier financing and investor financing
If a property is to be privately financed, a distinction is also made between investor financing and owner-occupier financing. With the former, the property is to be used as an investment. For example, it is purchased and rented out. In the case of owner-occupier financing, the property is to be lived in by the owner. Would you like to find out more about real estate used as an investment? We cover this topic in this post very detailed.
Use of equity and borrowed capital when buying a property
Many people who want to fulfill their dream of owning their own home cannot finance it 100 percent from their own resources. For this reason, most real estate properties are purchased at least in part with the help of borrowed capital. It is extremely rare for a property to be paid for in full in cash when it is purchased.
If the future homeowner can pay at least 20 percent of the purchase price from the equity they have saved, the lenders’ conditions improve significantly. This is due to the security that such a buyer brings with them. The more collateral a potential borrower can provide, the more flexible the banks are when negotiating the interest rate. You can find out what influence equity has on the closing of a loan in our article read more.
However, it is not always necessary to have equity in order to take out a loan for real estate financing. Find out how you can finance a property without equity and obtain loans for 100 percent or even 110 percent of the purchase price here.
Securing the financing
The lender wants to secure itself, which is why it usually places a mortgage on the property. The mortgage or land charge is recorded in the land register. If the borrower is unable to pay the agreed installments, the lender can foreclose on the property. In such a case, the lender bears the risk that the remaining debt cannot be settled with the proceeds from the foreclosure sale. Property prices have risen steadily in recent years. However, there is no guarantee of this. If the value of a property falls, the lender may require additional security in order to maintain the loan agreement. Due to consumer protection laws that came into force in 2008, a credit institution can only terminate a contract if there are arrears of 2.5 percent of the loan amount.
The individual financing options at a glance
In the following section, we present various options for acquiring outside capital. In Germany, state subsidies, building society loans, mortgage loans and insurance loans are used to finance a property. Each of these forms of financing has its advantages and disadvantages. But what are the differences between the individual financing options and which of them should be on your shortlist?
The mortgage or annuity loan
In most cases, the purchase of a property is financed with a mortgage loan. The loan is usually taken out with a bank and is handled as a so-called annuity loan. With this type of loan, a fixed installment is agreed at the beginning. This is made up of repayment and interest. As the loan amount decreases as repayment progresses, the composition of the installment changes. Most of the interest is paid at the beginning, but the repayment installment increases each month. A mortgage loan of this type is designed for a term of between 20 and 30 years. The ratio between interest and repayment, which make up the installment, can save interest. However, the fact that the repayment plan is fixed during the fixed-interest period could be seen as a disadvantage. In most cases, it is not possible to make changes to the contract, such as an unscheduled repayment. In our article “Real estate loans – what to look out for? you can read all the important information about mortgage loans.
The forward loan and the full repayment loan are special forms of the annuity loan.
The building society contract or building society loan
A building society is successful if it handles interest in such a way that it can achieve benefits. First of all, the customer saves money by paying a certain amount into his credit account with the building society each month. The building society pays low interest on this growing balance. A loan is then taken out with the building society, for which relatively low interest is payable. The customer normally pays into their savings account for 5 to 9 years. At the end of this period, they have saved 40 to 50 percent of the total amount. This portion is paid out and the remaining amount is taken out as a loan. In contrast to a mortgage loan, the installments are rather high. Repayments should be made quickly, which results in low interest rates. One advantage is that building societies require little security. They waive their customers’ land charges or are satisfied with a second-ranking land charge. The absence of additional collateral, as well as interest rate security and the possibility of making unscheduled repayments, are among the advantages of a building society contract. What customers perceive as disadvantages are the short repayment period, as well as the high closing fees and the low interest rates paid by the building society during the savings phase.
The combined loan or pre-financed building society loan
The pre-financed home loan and savings contract works as follows: At the time the contract is concluded, you receive the entire loan amount from the building society without having saved any money beforehand. You pay a fixed interest rate, but no repayments. Instead, you save a fixed amount each month in your credit account. When the home loan and savings contract is allocated, the loan and credit balance are paid off. Interest and redemption payments are only due on the remaining amount of the building society loan.
The main advantage of this combined loan is that you receive a loan immediately and can still enjoy the positive aspects of a building society contract. As a rule, building society loans can be repaid at any time with unscheduled repayments without incurring an early repayment penalty.
The disadvantage is that no repayments are made in the initial period. Instead, you pay interest and at the same time save the agreed amount in your credit account. This results in interest disadvantages compared to an annuity loan. The combination loan proves to be more expensive.
The variable loan
Variable-rate loans are primarily used for the short-term financing of real estate. The loan is not tied to a fixed borrowing rate; instead, the interest rate is regularly adjusted in line with real market interest rates. Builders considering such a loan should have a financial cushion and a certain appetite for risk. If there is a sudden rise in interest rates, they must be able to offset these unforeseeable additional expenses. This form of financing is worthwhile if a large sum of money is expected in the near future. For example, because an inheritance has been received or another property has been sold. If this happens, the loan can be repaid immediately. The interest rate is adjusted to the current situation every three to six months. Lenders are guided by the Euribor money market interest rate. This is the average interest rate, the Euro Interbank Offered Rate, at which most banks in Europe offer their loans.
The variable loan offers a number of advantages. For example, it can be terminated with a fixed notice period without having to pay an early repayment penalty to the bank. If the Euribor money market interest rate falls, the interest rate on the loan is adjusted. This improves the conditions. It is also possible to fix the interest rate and switch to a fixed interest rate if it is at a low level.
The main disadvantage of a variable-rate loan is the unpredictable level of interest rates. If these rise, the monthly installments are raised to a higher level. This worsens the conditions of the loan. If the borrower does not have a sufficient financial cushion, an increase in monthly installments can cause serious difficulties.
State subsidies
There are several options for state subsidies that you can fall back on.
Private individuals can obtain investment grants for energy projects from the Federal Office of Economics and Export Control (BAFA), which do not have to be repaid. You should also find out about regional funding programs. These are run by the local authorities and federal states.
Other subsidy options that are available when buying a property:
The Riester pension
The Wohn-Riester enables tax benefits and allowances. However, the contributions that have been subsidized must be taxed at retirement age. There are also special regulations if the property is sold on.
Existing Riester contracts are changed to a Riester housing contract. Capital that has been saved up to that point with the Riester pension can be used as equity. The later installment payment to settle the remaining debt can be reduced as a result. It is therefore advisable to continue paying the monthly contributions in order to be able to access the total amount of the state subsidy at a later date.
The particular advantages of a Riester home loan are the low interest rates and the possibility of shortening the loan term. The repayment installments can also be tax-deductible.
One of the disadvantages is that a Wohn-Riester is transferred to the heirs after death. The savings contract is not as flexible as other investment products. In addition, the taxes saved must be repaid immediately after the sale of the residential property. For example, the property may have to be vacated if you have to move into a nursing home at an advanced retirement age. Tax repayments are also due in the event of divorce or death.
KfW loan
KfW subsidies can be used above all for energy-efficient construction. A loan can also be considered if construction work is carried out on an existing property to increase the energy efficiency of the building. Loans with particularly low interest rates can be taken out from KfW.
Insurance loan
The basic idea of an insurance loan is to repay the entire loan amount in full at a certain point in time. An insurance loan is taken out, on which monthly interest must be paid. At the same time, contributions are paid into the life insurance policy each month. Interest and subsidies are paid out on these contributions, which accumulate in a savings account. At a certain point in time, the total amount of the loan is calculated from the contributions, subsidies and interest. This is then paid in full.
One disadvantage of the insurance loan is that the amount of the loan remains the same throughout the entire term. Unlike mortgage loans, no monthly repayments are made, which would continuously reduce the loan amount. The interest rates are therefore comparably high for an insurance loan. In addition, half of the loan amount paid out must be taxed. Additional costs are incurred by the borrower if the interest rate is adjusted.
Conclusion
The basic idea of an insurance loan is to repay the entire loan amount in full at a certain point in time. An insurance loan is taken out, on which monthly interest must be paid. At the same time, contributions are paid into the life insurance policy each month. Interest and subsidies are paid out on these contributions, which accumulate in a savings account. At a certain point in time, the total amount of the loan is calculated from the contributions, subsidies and interest. This is then paid in full.
One disadvantage of the insurance loan is that the amount of the loan remains the same throughout the entire term. Unlike mortgage loans, there are no monthly repayments, which would continuously reduce the loan amount. The interest rates are therefore comparably high for an insurance loan. In addition, half of the loan amount paid out must be taxed. If the interest rate is adjusted, the borrower will incur additional costs.
