12during the low interest rate period, the credo was to start with as high an initial amortization as possible, thereby minimizing the debt burden more quickly. Banks were also interested in ensuring that the loan was repaid quickly because it reduced the risk of rising interest rates on the principal in the future. Therefore they increased the initial repayment of a land charge loan. This was new in that in the past, when construction loan rates of 5 percent or more were charged, 1-percent amortization was quite common. Read below to find out why the importance of the repayment amount is crucial, and what the return to 1 percent repayment means.
The annuity loan – the most commonly chosen construction financing loan
Widely used in germany, this type of loan agreement is concluded for a specific term with an unchangeable (fixed) borrowing rate for both parties. And, at the same time, always fix constant monthly installments for interest and amortization. This period, which is usually fixed from five and up to thirty years, is called the fixed-interest period.
However, the fixed interest rate period says nothing about the total term of a loan or construction loan. If one decides, for example, for a ten-year fixed interest rate, the loan is not yet paid off at usual repayment. Total term is therefore the time required to fully repay the loan. At the end of the >interest lock-in period, the residual debt remains, which must then be further serviced with follow-up financing. Unless the customer can then repay the residual debt to the bank immediately in one amount.
Before conclusion of a baufinanzierung therefore also the (assumed) remaining term up to the complete repayment of the credit is proven. However, this is based on assumptions that will generally not apply in the future. In fact, this example calculation assumes the same conditions for the period of a second or third fixed interest rate as for the first, in order to illustrate what total term the customer should expect. But if interest rates have then risen (or fallen) at the end of the exemplary 10-year fixed interest rate period, these assumptions of the total term are no longer correct.
If a 1 percent repayment is required throughout the entire fixed-interest period?
Strictly speaking: in reality, in the case of an annuity loan, the repayment is only one percent for the first installment. And this is not quite right either. Interest and repayment are always calculated per annum (p.A.), i.E. Information per year. Annuity loans are billed on a monthly basis. This is why the interest rate and the repayment rate that starts with the first installment, for example for a full month, is not the annual rate. Rather, one twelfth of the annual interest rate or the annual repayment is due on the first due date.
A higher interest rate leads to a shorter total repayment period
That is why the addition is important: initial repayment plus saved interest. At the same repayment rate, the higher the interest rate, the higher the proportion of interest saved! What sounds paradoxical at first glance is, however, correct from a financial mathematical point of view: taken further, this means nothing else than that a higher interest rate leads to a shorter overall term of the construction financing. This also means that the higher the interest rate charged on the market, the lower the repayment can theoretically be. Why? Because with an annuity loan, the interest rate charged by the bank decreases over time, but the repayment rate continues to rise so that the monthly installment always remains the same during the fixed-interest period. This is the essence of an annuity loan with the advantage for the borrower of not having to face fluctuating monthly installments.
1 percent amortization offers advantages
The following example illustrates the differences in various percentage calculations: A loan amount of 500.000 euros with an initial one percent (annuity 2 percent) p. A. Repayment and a second at three percent (annuity 4 percent) p.A.Only after the first installment, the remaining debt is still identical. The installments amount to approx. 833 euro or 1.666 euro. After just the second month, however, the residual debt in example 2 is already 71 cents lower. However, this effect, which at first glance seems insignificant, has a massive impact on the residual debt during the term of the fixed-interest period. Because interest is always charged on the loan based on the remaining debt.
Of course, most borrowers realize that higher amortization shortens the overall term of the construction loan. But the amount of interest also has a strong effect. So example 2 is repaid about 23 years sooner with today's assumptions. And this is despite the fact that the customer has saved approx. 230.000 euros more than in example 1 in interest payments to the bank carries. Particularly since also here the default applies that borrowers should have settled the complete repayment up to the pension age.
Why banks offer the 1 percent repayment again
mattcastruccimazda.com 2 shows how the burden on households for the construction financing would increase if the repayment were more than one percent. At the current market rate of around three percent with a ten-year fixed borrowing rate, the monthly installments increase to 2.083,33 euro (2% amortization) or even 2.500.00 euro (3% repayment). As long as however the real estate prices do not yield lastingly, a 3 per cent repayment means, that much the dream of the own 4 walls must give up. This is why the 1 percent repayment is interesting for banks again. Which also returns to the policy before the historic low interest rate period of the 2000s.
What does the return to 1 percent amortization mean for prospective mortgage customers??
In the low interest rate period, the credo was. The higher the repayment the better. This was the best way to avoid nasty surprises (massively rising interest rates in the future) and to avoid extremely long overall loan terms. According to the motto: the faster debt free the better. Of course, a higher repayment is also better in the future, as one is debt-free faster. But even higher interest rates for the construction loan actually have a shortening term effect in the context of an annuity loan.
We recommend: now that the market environment is difficult, intensive and expert advice is essential. From our point of view also important not to trust seemingly cheap offers right away. Because first you have to comprehensively understand the dependency of debit interest rate fixation, initial repayment, interest and repayment amount as well as total term and residual debt risk. Only then is a future-proof, also affordable and feasible over a long period of time construction financing still possible.
Residual debt risk primarily affects first-time lenders. However, there are ways and means you should know to minimize this risk as much as possible.