Although real estate prices have skyrocketed in recent years, demand for houses and condominiums is still high. If your own budget is not sufficient for the construction or purchase project, real estate financing can help. Which possibilities this offers and what to consider, we explain below.
What is real estate financing and why do you need it??
The construction or purchase of a property is a big step, which wants to be well considered. In advance, you should think about what kind of property you want to buy and where you want to live. Are you interested in a townhouse in the Baroque style, have you always dreamed of your own farm in the country or should it be a luxury property in Mallorca, for example, in the coastal town of Puerto Alcudia? In this case, exclusive Port Alcudia real estate may be suitable for you.
However, the prices for luxury real estate can quickly reach seven or eight figures. And even single-family homes can be cost-intensive depending on the region and location. According to Statista Research Department, the prices for detached single-family homes in Germany at the beginning of 2022 were between 350.000 Euro (in Magdeburg) and 2.200.000 Euro (in Munich). You can find the statistics here. Only a few households can provide such sums from their own resources. For this reason, many people decide to finance real estate. In the context of real estate financing, you take out a loan for a specific purpose in order to buy, build or renovate a house or an apartment for. Depending on the project, real estate financing is used in the form of construction financing, a modernization loan or follow-up financing. The amount of the loan interest and the type of repayment depend on the respective form of financing.
What requirements must be met for real estate financing?
In order for the financing of the dream property to succeed, certain requirements must be met. First of all, it is important that you as a borrower are able to service the monthly repayments. The lending bank therefore checks in advance whether you are creditworthy.
The following requirements must also be met:
- Age of the borrower: If you want to take out a real estate loan, you have to be of legal age. Although there is no maximum age. However, real estate financing is more difficult when you're over 60 than when you're younger, because borrowers still need to have enough money to live on when they retire.
- Monthly income: The amount of income must match the monthly burden from the upcoming real estate financing. To check this, the lending bank requires, among other things, proof of income for the last three months.
- Mortgage lending value: Contrary to what is often assumed, it is the mortgage lending value that counts as collateral for the financial institution and not the market value of the property. Usually the mortgage lending value is calculated from the purchase price.
- Amount of equity: Experts recommend that property buyers bear at least 20 percent of the costs themselves (plus incidental acquisition costs such as land transfer tax). The reason: if the equity portion is less than 20 percent, and the loan-to-value ratio thus exceeds 80 percent, construction interest rates rise significantly. Therefore, the more equity you invest, the more favorable your loan will be.
Tip: Equity includes cash, bank and savings balances, building society savings, assets from securities (stocks etc.), paid building materials, as well as uncontaminated building plots. Never use all of your equity to finance a property. To ensure that you can cope with unforeseen expenses in everyday life, it is important to keep a cash reserve in your account.
What types of real estate financing are there?
Depending on your financial situation and the general level of interest rates, different types of loans are available for construction financing.
1. The annuity loan
The annuity loan is the best known type of construction financing. Here, you as the borrower pay a constant installment to the lending bank month after month. This is made up of interest and repayment (annuity). Due to the repayment, the loan amount decreases over time and therefore the interest payable also decreases. Since the monthly repayment rate remains the same, the repayment percentage increases accordingly.
You take out a real estate loan for the purchase of a house in the amount of 300.000 euros on. The debit interest rate amounts to per annum one per cent with a fixed interest period of 15 years. You choose an initial repayment of three percent annually because of the favorable interest rates:
- Debit interest rate (per year): 1,0 %
- Initial repayment rate (per year): 3,0 %
- Debit interest commitment: 15 years
- Annuity (loan amount*(interest+repayment)/100: 12.000 euros
- monthly installment: 1.000 euros
Over the years, the proportion of interest and repayment within the loan installment shifts. While the percentage of repayment is relatively small at the beginning, this changes significantly at the end of the term. With the help of an interest and repayment calculator this development can be exemplarily represented.
Full repayment loan
A full amortization loan is a special type of annuity loan. With this the debit interest commitment and the term of the credit agreement are identical. At the end of the fixed interest period, the loan amount is fully repaid and there is no remaining debt for the borrower. The loan offers good protection against interest rate increases.
2. Repayment Loan
With an amortizing loan or installment loan, although the monthly repayment rate remains the same throughout the loan term. However, this does not apply to the interest rate. Thus, over time, the repayment rate changes.
3. Maturity loan
The bullet loan is amortization free. As a borrower, you pay it off only at the end of the term with a one-time payment. Possibility of combining the loan with a building savings contract or a life/annuity insurance policy. You pay money into these regularly during the contract period. The later benefits you receive from this can be used to (partially) redeem your loan.