Getting the financing of an apartment or house right

Falk Ernst, GELDPILOT24-CRO Financing Part 2

20.05.2020

Basic knowledge

The repayment amount

How high the repayment rate should be in concrete terms depends on the period in which you want to pay off the loan. As a rule, this should be the case when you retire at the latest. If you are 25 today and want to be debt-free at 65, you will have lower monthly charges than a 45-year-old who takes out a loan of the same amount and also wants to be debt-free at 65.

 

The lower the interest rate, the higher the repayment should be. The lower the interest rate, the longer you need with a certain initial repayment to repay the loan. For example, with an interest rate of 5 percent and an initial repayment of 2 percent, it takes about 25 years to repay a loan. At an interest rate level of 3 percent, it takes about 30 years to repay the loan at the same repayment rate and almost 40 years at an interest rate of 1.3 percent.

 

Why is this so?

 

The reason for this is the constant loan installment to pay off the annuity loan, which is made up of interest and repayment. Through the regular repayment of your loan, the remaining debt decreases more and more during the term. This reduces the interest portion of the instalment. However, as the instalment remains constant overall, the redemption portion rises continuously due to the saved interest portion. When interest rates are low, the interest portion decreases more slowly - and therefore the repayment portion also increases more slowly than with higher interest rates. The logical consequence: you need longer to repay the loan for the same initial repayment.

 

The following table shows which repayment rates are necessary to be debt-free within a certain period of time at different interest rate levels:

 

Interest     1%     2%     3%     4%      5%
Duration
10 years  9.5%  9.0%  8.6%  8.2%  7.8%
15 years  6.1%  5.7%  5.3%  4.9%  4.5%
20 years  4.5%  4.0%  3.7%  3.3%  2.9%
25 years  3.5%  3.0%  2.7%  2.3%  2.0%
30 years  2.8%  2.4%  2.1%  1.7%  1.4%
35 years  2.3%  1.9%  1.6%  1.3%  1.1%

 

An important option: unscheduled repayment

 

During the fixed-interest period, the Bank cannot change the interest rate. But even you cannot have the interest rate "adjusted". Furthermore, you can only repay the loan in the agreed manner. Repayment rates of 2 to 4 percent of the original loan amount are usually agreed. An additional possibility is the agreement of a special repayment option. This gives you the right to make an annual special payment of a certain percentage (usually 5% or 10%) of the original loan amount.

 

Terminating the loan is not always possible

 

During the fixed-interest period, you cannot terminate your loan properly either.
The only exception: If you have agreed a fixed-interest period of more than 10 years, you can terminate the loan after 10 years with 6 months' notice. Then the entire remaining debt is due at the time stated.


If the property is sold, you can also terminate the loan extraordinarily. In this case, however, the bank may demand an early repayment fee. This is to compensate the bank for the interest loss incurred, i.e. the income the bank loses through the early redemption minus the bank's saved costs for the contract management.
 

Early Redemption Fee
 

Banks may not determine the amount they charge their customers as early repayment fees at their own discretion. In their calculations, they must take these points and costs into account and thus (in a simplified way) calculate them:

 

The loss from lost interest income in the event of premature termination of the loan contract during the remaining fixed-interest period.


These are to be deducted:


Saved administrative costs (bank)
Saved risk costs (payment default of the borrower)
Interest (alternatively for a Mortgage Pfandbrief in the corresponding period)


In addition, there are two other methods by which banks can calculate an early repayment fee:


Active-active method: Here, the interest income lost by the bank due to the early termination of the contract is compared with the interest income lost on a new loan agreement. This calculation is often advantageous for the bank customer in the current interest rate environment. However, only relatively few banks use it.


Asset-liability method: The agreed payment flows (repayment, interest and residual debt) of the currently terminated contract are compared with the interest income if a new contract with the same loan amount were now concluded. The difference between the two income values is then the early repayment penalty. Most banks use this calculation method.

 

The annuity loan


The annuity is a regular payment by which a loan is repaid in a fixed term. It consists of two parts: the interest payment and the redemption payment. As a result of the continuing payments, the proportion of the interest payment decreases over time and the proportion of the repayment payment increases. The payments can be annual, monthly or quarterly.
Here, the interest rate is contractually fixed for a certain period (fixed interest period) when the contract is concluded. Fixed interest periods of 5, 10, 15 or 20 years are frequently specified.
Less frequently, the periods of 8, 12, 25 or even 30 years occur. The longer the fixed-interest period, the higher the interest rate as a rule.


The special feature of this instalment form is the constancy of the payment amount. This means that the borrower pays the same, previously agreed amount over the entire term. The interest payments become lower and lower as the term progresses, but why?


The interest payment is based on the loan amount and this decreases due to the repayment. Since the interest payments become lower and lower as the loan period progresses, the redemption payment becomes higher and higher and the loan is therefore also reduced faster. Only the proportions of principal and interest payments change, but not the total amount of the annuity.
The following example makes it a little clearer:
Suppose you take out a loan of 100,000
The annuity is €5,000 per year and the interest rate is 3%.
The formula you need to calculate how your first payment is divided into interest and principal:
Interest payment = loan x interest rate = €100,000 x 3% = €3,000
Repayment = annuity - interest payment = 5,000 € - interest payment (3,000 €) = 2,000 €
Thus, your first payment will consist of 3,000 € interest payment and 2,000 € redemption payments.
When after a few months the amount of the loan has been repaid, let's say up to 70.000 €, the distribution of the annuity payment has also changed. You still pay € 5,000, but the interest payment is only € 70,000 x 3% = € 2,100.
The rest of the instalment is used for the repayment. This is now 2,900 €.


Interest payment = current remaining debt x interest rate = 70.000 € x 3 % = 2.100 €
Repayment = annuity - interest payment = 5,000 € - interest payment (2,100 €) = 2,900 €

 

The Combination Loan


In this form, as the name suggests, various financing modules are combined. The aim here is to represent a fixed interest rate over the entire term of the loan, that is, until full repayment, and to ensure maximum installment security for the borrower. At the same time, a high degree of flexibility should still be maintained.


An annuity loan is usually combined with a building society contract or a life insurance policy. The special feature here is often that the annuity loan is suspended from repayment. This means that during the fixed-interest period you only pay the interest on the loan and no repayments, because this interest flows into a savings product (repayment replacement product), for example a building savings account. At the end of the fixed-interest period of the annuity loan, the remaining debt is then redeemed by the loan of the repayment replacement product (variant life insurance) or continued to be financed (variant building savings account). A binding loan interest rate is also set for the building savings account when the contract is concluded. For this you have to save a certain amount of money beforehand (minimum saving). In the variant with life insurance, the credit balance is used to redeem the loan in full.


Here is an example: We again assume the 100,000 € loan amount.


100,000 € loan, fixed interest rate for 10 years, 2% loan interest, suspended repayment Thus, the interest payment is 2,000 € per year and the savings amount for the building savings account is 3,000 € per year.
Residual debt at the end of the fixed-interest period: 100,000 €
Credit balance of the building savings account: 30,000
Loan entitlement of the building savings account: € 70,000 at 2.5 % and max. 15 years term


With the credit balance and the loan from the building savings account, the annuity loan will now be redeemed and you will now pay the installment for the building savings loan agreed upon when the contract was concluded to the building society. In contrast to annuity loans, bauspar loans can be redeemed at any time free of charge in unlimited amounts.


The advantage of this form of financing is that you only have to negotiate the conditions with the bank once when you take out the loan and submit documents. Instalments and interest rate are then contractually agreed for the entire term, i.e. until full repayment. At the same time, however, you have the option of shortening the term by making additional payments into your building savings account (before and during the loan phase).

 

The disadvantage here is the higher costs. Because you do not repay the annuity loan, higher interest payments are made over the fixed interest period than with a "normal" annuity loan. In addition, the building society charges a so-called acquisition fee of 1 - 1.6 % of the total savings amount.


The variable loan


Variable loans work completely differently than annuity loans. They are called variable because there is no fixed debit interest rate. This means that the interest rates are regularly adjusted to the respective market situation, usually after three months, but can remain constant over several months even if the market situation remains the same. The interest rates are fixed using the so-called Euribor money market rate. Euribor stands for "Euro Interbank Offered Rate" and refers to the average interest rate at which a large number of European banks grant bonds. This is then used to calculate the interest rate plus a profit margin. The Euribor follows the key interest rate of the European Central Bank (ECB) in its development.


If the Euribor falls, the borrower benefits from this when the interest rate is next adjusted. If the interest rate rises, it is also due at the next adjustment. This means that an interest rate risk exists in any case. Variable loans are therefore hardly suitable for long-term financing. The normal term of variable loans is three to 15 years.


A variable loan is recommendable with expectably falling interest rates on the money market and in high-interest phases, since the difference to fixed-interest loans is particularly high here. Variable loans are not recommended if rising interest rates are expected. The use of a variable loan therefore always depends on the estimation of the interest rate trend in the near future.
A special form of the variable loan is the so-called cap loan. Here, the interest rate is contractually limited by a maximum limit (cap). If the market interest rate rises above the mark, it is no longer passed on to the borrower but remains at the maximum level. So if the cap ceiling is agreed at 4% and the market interest rate rises to 5%, the interest rate for the cap loan remains frozen at 4%. If the interest rate falls back to 3%, the interest rate for the loan also falls back to 3%.

 

 



Back to list