Property Financing for Beginners
Property financing: Here's what you can expect
Property financing isn't exactly everyone's favorite subject. We get it. That's what we're here for: to help you get up to speed on everything you need to know. When it comes to investing in real estate, there's no getting around choosing a form of financing. But if you'd care not to search around for financing offers and handle all of the business that follows on your own, no sweat — we can take care of it for you. So, ready to dive in? Let's get started.
When it comes to property financing, there are a lot of special terms that get thrown around, such as "annuity loan," "lock-in period," "amortization schedule calculator," "prepayment," and plenty of others. These terms basically mean that you are borrowing money from a bank, define how much you will have to pay back to the bank in installments, how much time you have to repay, and how high the borrowing fee is. The interest rate (in German: Zinssatz) is fixed for a specific period of time, known as the lock-in period. The lock-in period usually is ten years. If you are borrowing a higher sum, need more security for the future, or if you expect interest rates to still be high in ten years, you can also get a mortgage that has a reasonable interest rate that is fixed for 15 or even 20 years.
How much of the borrowed money you will want and be able to pay back each month will depend on your net household income and how much you make in rent from the property. Under no circumstance should you set your amortization payments too high. It's essential to hold on to your financial freedom. An amortization rate (in German: Tilgung) of 2% is always a good choice.
The most important figure that goes into calculating the interest rate and amortization schedule is your own capital. That is, how much money you are personally able to put on the table and how much you will need to borrow from the bank to buy the property you want. The more of your own money you can put towards the purchase, the lower the interest rate the bank offers you will be.
If you don't have a large amount of personal savings, you can also borrow a specific portion of the asking price from friends, family, or the seller. Putting together a mix of private loans and an annuity mortgage is typically easy to do, and it pays to do so. You can find all the information you need on this topic in our article "Financing Property without Equity". And here are all the facts about optimal property financing.
You prefer to listen to the compact version? Then just start the podcast episode. (German audio only)
Optimal property financing: Navigating the property financing jungle
Real estate properties are typically financed by taking out a loan from a bank. In other words, you borrow a specific amount from a bank and then pay that money back over an agreed period of time, plus interest. The most common form of loan for real estate financing is the annuity mortgage, which has a fixed interest rate for the entire loan period. If you agree to pay back €500 every month, this is the amount you will pay until the loan is entirely paid off. The interest rate remains unchanged for the entire duration of the lock-in period. However, with each monthly payment, the ratio between your interest and your remaining balance changes. Each payment lowers the balance you owe to the bank. As your debt decreases, the amount of interest you pay relative to your remaining balance decreases, and the amount of each monthly installment relative to your remaining balance increases.
Pretty straightforward, right?
Annuity mortgage options
Before you settle on an interest and amortization rate, you should play around with the numbers a bit and come up with an interest rate calculation and amortization schedule. Doing this will very quickly show you which rates are going to work best for you. There are a few factors you can adjust to make your mortgage better fit your situation.
Fixed-interest rate (in German: Zinsbindung):
Banks offer different lock-in periods, ranging from five to 10 years, 15 years, 20 years, 25 years, and even 30 years. The lock-in period is a period during which the bank will guarantee you a fixed interest rate. It gives both you and the bank the ability to plan for the long term. Typically, the interest rate is fixed for ten years. If you need more security, a lock-in period of 15 or 20 years might be worth considering. Of course, it's also possible to fix the interest rate for 30 years. However, the bank will want to charge you a premium for the added security, resulting in an interest rate roughly 0.2% to 0.5% higher than it would be with a shorter lock-in period.
On the other hand, if you intend to fully repay the mortgage before the lock-in period ends, the bank will reward you with a lower interest rate. In Germany, this is called a "full repayment mortgage" (in German: Volltilgerdarlehen).
If the interest rate goes down during the agreed lock-in period, you won't be able to take advantage of the lower rate. Instead, you will be required to continue paying the agreed (higher) rate. The earliest that you would be able to refinance the remaining balance on the mortgage at the lower interest rate would be after the 10-year lock-in period has expired.
Don't tie yourself to a specific interest rate for too long.
Special repayment (in German Sondertilgung)
As you can probably imagine, special repayment is when you make unscheduled, early payments against your mortgage balance. In addition to your monthly installments, you can arrange contractually to make a one-off prepayment or regular prepayments against your credit. These unscheduled payments make it possible to arrive quicker at your goal of paying off your loan in full. Even if you start with a lower amortization rate at the beginning, making prepayments along the way can help you speed up the process of paying off the entire loan. You are generally allowed to make prepayments equal to up to 5% of your loan per year.
If you think you will be able — and willing — to put forward more of your own money at least once during the repayment period, take advantage of this opportunity and have the bank include this option in your agreement.
The amortization rate (in German: Tilgungsrate)
The amortization rate is how you set the borrowed sum you will pay back each month. It's vital never to choose an amortization rate higher than your personal finances allow — you just end up boxing yourself in financially. Take a close look at how much rental income your property will generate for you. Since your mortgage will have a fixed interest rate, the amount of interest you will have to pay each month is already decided. However, the fixed interest rate allows you to quickly calculate how much money you will have left over each month to put towards the amortization.
Let's say you borrow €150,000 from the bank at an interest rate of 1.3%. Each month, you pay (€150,000 x 1.3%) / 100 / 12 = €162.50 in interest. Your rental property generates €400 in rent each month. That means that you will have €400 − €162.50 = €237.50 available for amortization.
Calculated for the whole year, this would be €237.50 x 12 = €2,850. Which corresponds to an amortization rate of (€2,850 x 100) / €150,000 = 1.9%. Right on track.
Commitment fees (in German: Bereitstellungszinsen)
If you have your eye on an apartment or house as an investment opportunity, but the property hasn't actually been built yet, you might have to pay commitment fees to the bank. The purchase price isn't paid as a single sum for newly built properties but in parts as construction moves forward. That means the bank puts a portion of the loan aside for you. How long the bank will put the money on hold for you depends on what is called the "commitment fee-free period" (in German: bereitstellungsfreie Zeit), which is usually six months. Some banks, however, will even let you request the money within 12 months without incurring additional costs (commitment fees). Commitment fees are basically a fee you owe on the amount of money that hasn't been paid yet. The average is 0.25%.
If you rent out your property, you can claim the commitment fees as a tax deduction.
Other important thing to know about annuity mortgages
Unlike other types of loans, the money from your annuity mortgage can only be used to finance the property you are buying. The bank will also add itself to the land register (in German: Grundbuch) as a sort of collateral when you opt for this form of property financing. If you aren't sure what the land register is or why you might want to have a look at it when you're planning on buying real estate, no worries — we've put together all the information you need right here.
If you don't manage to pay off the mortgage in full by the time the lock-in period ends, you'll need to arrange follow-up financing for the remaining balance. And this is where the only real risk with annuity mortgages comes in: if interest rates have gone up significantly since your lock-in period, this may result in added financial burden for you. In this case, you may need to do another interest rate and amortization schedule calculation and make adjustments to your amortization rate or plan to make prepayments. Generally speaking, you'll want to have the mortgage paid off in full by the time you retire to avoid accruing even more financial burden.
You can find plenty of questions, answers, and discussions about this topic in the Urbyo Community. Stop by and have a look. In the meantime, we're working on developing new features that will allow you to forecast interest rates.
Listen to what our experts Oliver and Nina have to say about this.
Annuity mortgages aren't the only way to finance real estate
If you're looking to finance a real estate purchase, you don't always have to go with an annuity mortgage. There are, in fact, other forms of financing you can use, such as interest-only mortgages and Riester pension plans for real estate purchases (in German: Wohn-Riester). Not sure what these are? Here's an explanation.
Interest-only mortgages (in German: endfällige Darlehen)
An interest-only mortgage combines a loan and an endowment policy or loan agreement (usually a home loan and savings contract, in German: Bausparvertrag). The returns from the endowment policy or the home loan and savings contract can be used to generate a credit balance, and until the loan term has ended, you are only required to pay the interest on the loan each month. When it's time to repay the loan, you'll use the credit balance from the now mature endowment policy or home loan and savings contract to make your amortization payments.
However, with this form of real estate financing, you are at the mercy of the market and the returns you make (e.g., from your endowment policy). That means that if your returns are less than the interest you owe on the loan, it won't work. But if your primary goal is to get a specific interest rate after the lock-in period ends on your main loan — as a sort of safety net — this could be an option. Tax savings could be another aspect worth considering. In any case, make sure you learn about all the opportunities and risks associated with this form of financing. If you have any questions, we're just a click away.
Riester pension plans for real estate (in German: Wohn-Riester)
The Wohn-Riester is a home ownership pension saving scheme. It's a form of Riester pension plan designed to subsidize the purchase of real estate. It's supposed to enable you to live rent-free in a home of your own once you enter retirement. However, if you're looking to buy real estate as an investment, the Wohn-Riester won't do since you are only entitled to this plan's allowances and tax benefits if you live in the subsidized property yourself. Complete information is available from the German Central Office of Allowances for Retirement Funds (Zentrale Zulagenstelle für Altersvermögen, ZfA) and us. Get in touch with us to learn more.
How to finance a property without a bank (in part at least)
Of course, the bank isn't the only source you can borrow money from. Loans can also be taken out with friends and family, your employer, and even the property seller. In this case, the loan is negotiated between you and whoever is lending to you. You can find all the information you need about obtaining personal loans in our article "Financing Property without Equity," including how to arrange vendor take-back mortgages, subordinated loans, company loans, and additional collateral. Go ahead and give it a read to see if any of the options might work for you.
You can also often obtain loans at significantly lower interest rates through the KfW (Kreditanstalt für Wiederaufbau) or subsidy programs run by Germany's federal states and municipalities. However, you may never use these subsidiary programs to finance the entire asking price of the property.
If you can't cover the rest of the asking price with your own money, there's no getting around securing property financing through a bank. But no need to worry: we're here to help. You can leave all the complicated stuff to us.
You're not alone
We understand how time-consuming and frustrating property financing can be. It's often completely unclear how to go about finding the best offer, and you can very easily find yourself wondering if you've missed out on a better option somewhere along the line. But we've got the answer for this, too: mortgage brokers. Mortgage brokers are independent financial intermediaries that help you find the offers you want quickly and easily. They're your direct line to the banks. Mortgage brokers use software from major providers, which allows them to see the latest conditions from all integrated banks in just a few clicks. With this information, they can find and send you the best offers for various lock-in periods, amortization scenarios, and loan term scenarios. That means you only have to deal with one point of contact, but you have access to offers for annuity mortgages and other property financing models from a wide range of banks. Pretty cool, huh?
What mortgage brokers do is good for business from the banks' point of view as well, since the core of the banks' business revolves around lending money at interest. Customer acquisition and care aren't exactly of central importance in property financing, and this is where the financial intermediaries come into play. They help the banks get rid of their loan volumes, advise the borrower, and handle all the paperwork according to what the banks require. The only thing the banks need to do is to provide the brokers with up-to-date conditions. The brokers then receive a commission from the banks for their work.
Good to know
Not just anyone is allowed to broker mortgages in Germany. You have to complete a course, obtain a certificate of competence, reside in Germany, and have indemnity insurance to operate as a financial intermediary. Mortgage brokers are also legally required to keep documentation and to provide advice to borrowers. The bank that ultimately awards you the mortgage will check meticulously that this requirement has been fulfilled.
So, mortgage brokers help ensure that the process of finding the right financing offer is easy for both you and the bank. You get a convenient overview of the financing options available to you, and the bank gets to focus on what it does. And you both have the same point of contact. When you invest with Urbyo, you have experts on your side the entire way.
Straight and to the point: Your options for financing real estate
By this point, you should be familiar with quite a few ways to finance real estate, as well as who you can get in touch with when you have questions: we're here whenever you need us. In a nutshell, you want to make the investment process as easy for yourself as possible and let experts handle the majority of the work for you.
To reiterate, when you're calculating interest rates and your amortization schedule, you want to make sure that the monthly installments fit your budget. Ideally, you want to put forward some of your own money as well — between 20% and 25% or so — in order to get a lower interest rate. As far as the lock-in period goes, be careful not to end up paying too much for the security it provides. But even if it's worth it to you, remember that the lock-in period will expire after ten years — no ifs, ands, or buts about it.
Sadly, there's no blueprint for property financing. The variability between different properties, people, and situations is simply too great. However, from experience, we can say that the closest thing to a blueprint out there is the annuity mortgage (in German: Annuitätendarlehen) because it really does fit most investment situations. It's also a relatively straightforward form of financing, which is a good thing. Because if you don't understand what you're getting yourself into, it's best to just avoid it — especially when it comes to property financing.