Financing

Essential details and terms at a glance

So, you would like to buy a residential property but have not quite figured out what your financing options are? This page will tell you everything you need to know on the subject of financing when buying a residential property. In most case, buying a residential property is largely defined by a person’s financial circumstances, and therefore depends very much on the right type of financing arrangement.

For the majority of home buyers, this means they need to familiarise themselves with the various financing options to get a general overview of their choices. After all, few buyers have enough capital on hand to pay for the property without taking out a loan.

Important questions at the very start of the process may include the following:

  • How many different types of loans and lenders are there?

  • How much equity capital should I pay down?

  • What do you do when you have little or no equity to pay down?

  • What is the current interest rate situation, how is it defined, and in what ways could it change?

  • Are there are subsidies or funding programs you could take advantage of?

  • Which technical terms are important to know when trying to obtain financing for your own property?

You will find answers to these and other questions that relate to the financing of residential real estate on this page along with additional links and articles.

Essential and latest items at a glance:

  • New federal funding for efficient buildings

  • Stable interest level for real estate loans

  • Increased KfW funding for home buyers and owners

All articles

First steps in residential property financing

When buying property, everything hinges on your financial situation. The sensible thing to do therefore is to start by soberly and objectively assessing your possibilities before weighing the options available to you on the market. A lot of the open questions can be put into context and sorted out early on by realistically appraising your liquidity, your net worth, and your aspirations and plans for the future.

Equity capital and debt capital

The key question when you start out is probably this: How much equity capital do you have at your disposal? Can you pay for the chosen property with your own funds or will you, like most home buyers, require financial support in the form of borrowed capital?

But even when borrowing, for example by taking out a bank loan, the question how much equity capital you bring to the table remains highly relevant. Because in addition to proof of your regular monthly income, the amount of equity available for the property acquisition represents a key factor for the decision whether or not to grant you a loan.

Below, we will take a closer look at what is probably the most important and most common form of financing: the type of loan often called mortgage loan in the real estate industry.

Borrowing as one form of financing a residential property

How many types of loans are there? Principally speaking, you need to differentiate between private loans and bank facilities.

In the first case, a private individual lends money to another private individual or to a company, as the case may be. In return for granting the loan, the private lender is entitled to interest as compensation for the risk shouldered and the temporary loss of liquidity.

In the case of a bank facility or bank loan, the most common lending type, additional money is created through the granting of the loan, the so-called deposit money – because banks may grant several times the value of their deposits in the form of loans, but currently only have to deposit one percent of the total loan sums handed out as a minimum reserve at the central bank. As with the private loan, the borrower pays interest for the risk incurred by the bank and to compensate for the temporary loss of liquidity.

Various types of loans

The various forms of loans differ considerably from one another, each being designed to meet the individual needs and circumstance of the borrowers. The market offers the right kind of loan for just about any financial situation. This is suggested not least by recent figures which show that demand for real estate loans keeps going up, and continued to increase even during the coronavirus pandemic. Outlined below are the most important and most common types of loan:

Annuity loan

A classic type of loan in the area of real estate financing is the annuity loan, also called annuity credit. With this type of loan, the initial repayment rate, the interest rate and the resulting monthly rate are fixed in advance for a certain period of time. Since the monthly rate remains always the same, the repayment portion increases whereas the interest burden decreases over time until eventually the rate consists almost entirely of the capital repayment component. As a rule of thumb: The higher the capital repayment component, the sooner the loan will be repaid. At maturity, the so-called end of the fixed-interest period, the remaining debt will be refinanced at the going interest rate, until the full amount of the loan is finally paid off.

Important to know is also that interest rates tend to increase in proportion to the loan term, meaning they will be significantly higher for a 20-year maturity than they would be if the loan matured after just five years. Accordingly, negotiating a high capital repayment component makes sense even and especially in the case of long loan terms.

A major advantage that annuity loans offer to borrowers is that they make your planning easy, since the monthly rates are set in advance for a certain period of time and will not change during this period.

Here is a well-known drawback: In a lot of cases, it proves impossible to repay loans with five- or ten-year maturity ahead of time, necessitating maturities of fifteen to twenty years.

Good for families: annuity loan combined with a family mortgage

For families with children, the family mortgage offers an attractive advantage. It offers interest rate discounts of 0.25 percentage points per child on annuity loans that are used to finance owner-occupied residential properties within the first five years, permitting a higher capital repayment component from the start.

Full repayment loan: an option in case of high income or high equity share

In the case of a full repayment loan, the interest rate and monthly payment rate are fixed all the way to the final repayment, including the remaining debt that would be due at maturity in the case of an annuity loan. Just like with an annuity loan, it is safe to say: The higher the initial repayment rate, the sooner the loan debt will be repaid. The interest rate will increase—again, as with an annuity loan—in sync with the chosen maturity.

The advantage being: On full repayment loans with terms longer than ten years, banks tend to charge lower interest rates than on annuity loans with similar terms, because these loans—unlike annuity loans—cannot be repaid prematurely. Buyers should therefore be sure of their ability to pay the high monthly rates, whether it be on the basis of a high income or of equity capital on hand.

Key factor for conventional loans: equity capital

As mentioned above, the amount of available equity plays a significant role in the granting of the mortgage financing arrangements just discussed. As a rule, buyers should pay down 20 to 30 percent of the purchase price plus the incidental acquisition costs, which include the real estate transfer tax, notarial and land registry fees and possibly an estate agent’s fee, out of their savings that are to be used as equity capital. Assuming a loan amount of 250,000 euros, this would imply an equity share of 50,000 to 75,000 euros.

Many would-be borrowers fail to obtain loan financing not because of their monthly income, but because of insufficient equity capital. One way to bypass this issue is a surety bond as alternative to equity capital. In the case of a surety bond, a third person guarantees to the financing bank that he or she will assume liability if the borrower becomes unable to make the loan payments.

Digression: a breakdown of incidental acquisition costs

The equity capital that a lender demands will be used not only for a pro-rata payment of the financed amount but also, as mentioned above, to pay for the so-called incidental acquisition costs. What are the components of the incidental acquisition costs?

The real estate transfer tax becomes due whenever a plot of land is sold, including when property on that land is sold. It is charged once at the time of sale and is based on the selling price quoted in the sale-and-purchase agreement. The real estate transfer tax rate varies from one German state to the next, so that it depends on the state in which a given property is located.

The real estate transfer tax should not be confused with the property tax, which is levied on real property on an annual basis. The latter is a municipal tax and charged by the town where the property is located. The owner is notified about the amount of the property tax by the competent inland revenue office via a so-called property tax notice, and the tax is usually paid quarterly.

Notarial fees are another component of the incidental acquisition costs, and these amount to roughly one to two percent of the selling price. Since the notary is usually hired by the buyer side, the bulk of the notarial charges is paid by the buyer. Conversely, the seller usually pays only a fraction of the costs, for instance whenever changes in the land register are required.

Speaking of land register: Land registry fees represent another component of the incidental acquisition costs and usually amount to roughly half a percent of the selling price. Accurate entry in the land register is very important because this is where the ownership of the residential property is officially recorded. Assuming a group of persons—for example, as a community or company—holds property shares, then each individual person must be entered in the land register, in each case quoting the respective ownership interest. It is the only way for parties with a legitimate interest to establish the statuses of ownership.

Last but not least among the incidental acquisition costs is the estate agent’s fee, where applicable. Prior to a recent change in German law, estate agents charged the entire fee to the buyer, and it usually amounted to a tidy sum: Prospective owners used to pay up to seven percent (value added tax included) of the selling price to the estate agent. Assuming a hypothetical selling price of 300,000 euros, the agent’s fee exceeded 10,000 euros. However, a law to reform the estate agent fee became effective in mid-2020 which stipulates that the fee be split halfway between seller and buyer so as to relieve would-be home buyers.

Option of choice in case of little or no equity: whole loan

An option remaining open to buyers with little or no available equity is to take out a whole loan. In the case of a whole loan, the lender fully finances the entire amount of the selling price, and sometimes even the incidental acquisition costs on top. The maturity in this case is the same as for an annuity loan, but the interest rate is significantly higher, in some cases by as much as an extra 200 basis points.

This financing model is particularly attractive for young buyers with a high income, particularly so if they are about to buy a comparatively small ownership apartment, because the difference between the payment rates and an assumed rent for the same apartment tends to be minimal in such cases.

Flexible option: fixed-interest loan with options

Buyers anticipating a significant growth in assets in the near future should take a close look at a certain type of fixed interest loans with options whose German name translates into “8-plus-5 loan.” The name derives from the fact that, while the interest rate is fixed for a period of 13 years, you have options after the eighth year: You may either continue to make payments for another five years on the same terms, or refinance by negotiating a new loan, or fully repay the loan at once. If, for example, you expect to come into an inheritance or to sell another property, you may pay off the debt on the newly acquired property after just eight years while having the extra security of a 13-year fixed interest period.

Important notes on interest and interest rates

The feasibility of a financing arrangement to buy real property depends, in addition to the equity issue, on the current interest environment as well. Something that applies to any kind of loan in every sector: Interest rates depend on the key lending rate.

The key lending rate is set by the European Central Bank (ECB) with the aim of keeping price levels stable within the eurozone. As a result, the ECB has a major influence on the economic situation, inflation and the current exchange rate. Here is why: Low interest rates enable banks to acquire more favourable loans, which in turn means that the banks can issue their own loans to companies and private individuals on more attractive terms.

The underlying idea it to boost potential investments. A side effect of the low level of interest is that savers earn only negligible returns on savings deposits, which makes it a more rewarding proposition to invest them in residential property, for example. With this in mind, it is surprising to see that the savings ratio in Germany clearly exceeds the homeownership rate.

Outlook: interest rate trend

There have been manifest signs lately that the days of very low interest rates may be over. To be sure, it could takes years or even decades yet before the eurozone returns to an interest level as high as it was prior to the onset of the financial crisis. At the time, the key lending rate stood at around five percent.

We have already seen interest rates perk up in recent months. For example, while building finance rates had dropped to 1.06 percent in early 2019, thereby undercutting the historic low of 2006 (1.11 percent), they reascended by nearly two percentage points in June 2022, up to about three percent. One main reason for this is the currently high inflation rate.

For prospective buyers, however, it is still safe to say: The interest level in Germany has been, and remains, comparatively attractive for residential property investments.

Homeownership: currently available subsidies and grants

If you are toying with the idea of buying a residential property, it makes sense to check out the various funding programs available on the German market. Many buyers do not realise: In addition to federal institutions such as the KfW development bank, the German states also grant subsidies and building loans. It pays to compare the funding options of the respective state with the federal funding programs offered by KfW Bank ahead of time, because in some cases the regional funding may be more advantageous than a given KfW scheme, while sometimes it is the other way round.

But what sort of subsidies and grants does KfW Bank actually offer? The section below will take a closer look at each option.

Available KfW funding

The federal KfW development bank (“KfW”) offers a variety of subsidies and loan options. Exactly which KfW funding scheme is best suited in a given case depends primarily on the type of project – with choices including soft loans as well as one-off payments.

The KfW homeownership program would be an option for the acquisition of a residential property intended for owner-occupancy. This loan-based funding program supports buyers in their investments with up to 50,000 euros.

If you have your eyes on an energy-refurbished residential property, you should look into the KfW funding program for energy-efficient refurbishments. Applicants may be eligible for up to 30,000 euros as a one-time grant – per apartment. The advantage being: This funding program may be flexibly combined with other public funding options.

In addition to one-off subsidies for refurbishments, KfW also offers energy-efficient refurbishment funding in the form of soft loans. These are low-interest loans up to a financing total of 100,000 euros—per apartment—if the building is being upgraded to the so-called “KfW efficiency house” standard. One-off measures or packages of such measures are eligible for up to 50,000 euros in funding.

For more information on these and other funding options as well as further details on other KfW options, see the dedicated article “Overview of KfW funding programs for apartment buyers”.

Other facts and special cases in residential property financing

Homeownership when self-employed

Naturally, every project and baseline scenario is different, especially when it comes to potential first-time home buyers. The cliché that only lawyers, physicians and other top-earners are in a position to contemplate homeownership has long become obsolete. Considering the diverse loan and funding options, homeownership seems to be open to just about anyone.

Even the self-employed now stand a good chance to realise their dream of homeownership, for example via one of the loan options discussed above. However, since the monthly income of self-employed people is often subject to fluctuations depending on their order books, the loan approval process should be expected to take longer. Here, banks will normally request a number of relevant disclosures, such as profit calculations, tax assessment notices and annual financial statements, so as to get a thorough understanding of the financial situation on which to base their decision.

Private lessors gaining ground due to low interest rates

The favourable interest situation is also reflected in the stats. According to the German Economic Institute (IW), the number of private landlords increased by nearly 750,000 households between 2010 and 2018 – possibly a sign that these took advantage of the attractive current conditions for the acquisition of residential property. Especially in major German cities, the number of private landlords increased by roughly one third. By the way: While it is often assumed that most residential real estate is owned by large housing conglomerates, private owners actually represent the most important group of landlordsin Germany.

Fiscally relevant: depreciation for wear and tear

Speaking of lessors: Property owners who rent out their premises are moreover entitled to a pro-rata deduction of their cost and productions values as advertising costs on the ground of the so-called “deduction for depreciation” tax allowance. However, this rule does not apply to owners who plan to owner-occupy their properties.

But the lessors among the property owners may use straight-line depreciation with a depreciation rate of two percent on the construction costs for up to 50 years.

Conclusion

Financing options in Germany’s residential real estate sector are quite diverse, and range from classic loan financing, to flexible options for parties with plenty of equity capital, and all the way to one-off grants or subsidies from the KfW development bank. The interest rate situation remains favourable, and is still at a level comparatively favourable for borrowers.

For these and other topics involving real estate, browse our knowledge blog at: https://accentro.de/en/knowledge

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