Interest rates for property financing and the loan-to-value ratio: what factors influence the interest rate conditions?

When the fixed interest period expires, you have to refinance your property loan at current interest rates. For follow-up financing agreements with the lender of your current loan (known as an interest rate adjustment agreement (Zinsanpassungsvereinbarung) or renewal agreement (Prolongationsvereinbarung)), this is usually agreed in the loan conditions. If you change lenders and take out a refinancing loan (Ablösekredit), these lenders will also base loans of this kind on their current borrowing rates. The level of interest rates for property financing is thus the key factor influencing the conditions of a follow-up financing arrangement.

Another important aspect is the relation between the outstanding residual debt and the mortgage lending value, otherwise known as the loan-to-value ratio (Beleihungsauslauf).
Generally speaking: the lower the loan-to-value ratio, the more favourable the interest rates. This means that anyone who succeeds in repaying a large part of their property loan as scheduled or particularly by way of special redemption payments (Sondertilgungen) by the time the fixed interest period or fixed interest-rate agreement expires not only lowers their residual debt. They also raise their chances of being granted relatively favourable interest rate conditions for their follow-up financing.

Higher market value = higher mortgage lending value = more favourable loan-to-value ratio: why is this assumption wrong?

Before making a loan decision of any kind, lenders have to assess the risk of the loan. For property financing, this particularly includes an examination of the value of the property that serves as collateral for the lender by way of a mortgage. The value calculated here and to be monitored in the further processing of the loan is not the market value or current value but the mortgage lending value (Beleihungswert).

The mortgage lending value is different from the market value or current value. It involves an assessment that focuses on the lasting and sustainable features of the property concerned. A mortgage can only fulfil the objective of assuring that the lender is sufficiently collateralised at all times during the term of the loan if the property is valued according to these aspects. Market value or current value, on the other hand, are not based on long-term assessments but are valuations carried out on a specific date. The supply and demand situation of comparable houses, apartments or plots of land in similar locations are of particular importance for these value assessments. Unlike mortgage lending value, market value/current value can therefore fluctuate significantly.

Market value/current value that rise in response to a boom on property markets are not normally reflected in the mortgage lending value, or only after a considerable delay in time. Calculations of mortgage lending value do not consider speculative elements. They also disregard brief phases of economic downswing. However, sizeable price corrections on property markets, for example, might indeed give lenders reason to make downward corrections to mortgage lending values.

Interest rate adjustments/renewals or refinancing loans: what courses of action do lenders have?

From the lenders’ perspective, refinancing loans constitute new business. In addition to thoroughly examining your debt-servicing capacity, the lenders will also assess the recoverability (Werthaltigkeit) of the collateral. To do this, they will normally carry out their own current valuation of the property.

Whether there is a need to carry out a renewed creditworthiness assessment in the case of outstanding annuity loans depends on the conditions set out in the loan agreement. If the lenders do not need to make a new loan decision in order to carry out an interest rate adjustment, they may refer to older information that is available to them. However, from the moment the loan is granted, all lenders must make an assessment each year as part of the further processing of the loan of the counterparty default risk, i.e. the risk that the borrower cannot or does not wish to repay the loan granted, whether in full or in part, as contractually agreed. Moreover, they must monitor the recoverability of the collateral. If signs of a deterioration in the value of the collateral come to light, the lenders might need to revalue the property. If indications of substantial negative changes in the value of the collateral become apparent, the lenders must also conduct an examination outside the annual assessment cycle. The lenders will also take into account any deteriorations that they have determined even if this is merely for an interest rate adjustment of a further section of the overall term of the loan after the preceding fixed interest rate period has expired.

What are the consequences of higher interest rates?

If the residual debt has to be repaid at an interest rate that is higher than the previously agreed interest rate, borrowers risk having to make higher instalment payments or pay the instalments for longer periods of time. Depending on your age at the time you bought your home, this could mean that you will still be repaying the property loan while you are in retirement.

The situation can become especially problematic for consumers who

• have raised loans in high amounts for short fixed interest periods,
• have raised loans in high amounts and paid off relatively little during the fixed interest period or towards the end of the period, or who
• are already stretched to their limits with their current financing.

In a worst case scenario, in which the residual debt and new interest rates are so high that the monthly amounts available to the borrowers for the instalments are no longer enough to cover the interest rate and redemption payments, it might not be possible to arrange an interest rate adjustment or renewal and the borrower might thus be unable to find a lender for a refinancing loan. This would be the case at the very least if the borrowers were unable to furnish additional collateral.

What you can do

Deal with the situation in good time

Keep a careful eye on when your fixed interest period is due to expire and how high your residual debt for this period will be. Make sure that you start giving thought to the interest rate adjustment agreement before your lender contacts you. Monitor how interest rates for property financing are developing and probe the media for information on the relevant market for your property.
It is often very difficult to understand how things interact, particularly with regard to the mortgage lending value. Obtain advice in good time if you are unsure about the consequences that a certain development could have for your loan.

Repay as much of your mortgage as possible in order to benefit from more favourable interest rates for your follow-up financing

The lower the residual debt at the end of the fixed interest period, the lower the interest rates will be for the interest rate adjustment agreement or refinancing loan. Give sufficient thought to how much you are able to pay under the current agreement. Calculate in good time the amount by which you would need to lower your calculated residual debt in order for you to benefit from a more favourable interest rate. Find ways to afford this amount so that you can use the favourable interest rate to your advantage.

Many agreements allow borrowers to make special redemption payments each year of up to five or ten percent of the loan amount. They also often contain provisions stipulating that the monthly instalment rates can be raised in a certain amount. If no such arrangements were made when you signed the loan agreement, set aside any available amounts in order to make a repayment when the fixed interest period expires.

Obtain advice

Customer advisors at banks, Sparkassen or insurance companies are subject to considerable obligations when making individual recommendations for follow-up financing. They are required to offer advice that is geared to the customers’ needs and does justice to the project requirements. Property loan brokers offering independent advice or operating as independent advisors must also take your financial situation and personal circumstances into account when making recommendations and base these recommendations on a sufficient number of options offered on the market.
Make use of such offers of advice. Provide your advisors with all the necessary information. Hold them accountable for finding a solution that suits your needs. Talk to several advisors and compare their offers.

It can also prove helpful to discuss offers of follow-up financing with independent experts, for example at consumer advice centres. This is particularly the case for consumers who could find themselves in a tight spot financially.

Take a close look at forward loans

Many lenders offer consumers the possibility of agreeing a new interest rate fixation period long before the current fixed interest period expires. If you are expecting an increase in interest rates for property financing or wish to secure interest rates at the current market rate, you might consider the possibility of taking out a forward loan. Some lenders offer forward loans up to five years in advance. Bear in mind, however, that for every month until the end of the current fixed interest period and until the start of the loan at the conditions of the forward loan and/or the disbursement of the forward loan, you will have to pay an interest premium that, depending on the lender, can vary in amount.
Use a consultation with the lender as an occasion to discuss whether and when it might a good idea to take out a forward loan of this kind.

Be wary of recommendations found on social media

You can find a great deal of advice on the topics of property financing and follow-up financing on social media platforms such as YouTube, TikTok, Reddit amongst others. Many of the explanations and tips are easy to understand and helpful. Others are incorrect or misleading. A common example, often advertised as a “bonus tip”, is having a property revalued. Consumers are led to believe that, if they present the market value appraisal to the lending bank, the lender will have reason to assume a better loan-to-value ratio. As explained above, however, the market value is not the decisive factor here. Consumers whose credit rating has deteriorated are also often recommended to stay with their current lending bank at all events. They are led to believe that their current lender would not carry out a renewed credit assessment. This is also generally not true. The target for dubious tips of this kind are often consumers who have run up high debts in order to buy their homes and still have high residual debts to repay on expiry of the fixed interest period. If you decide to explore such platforms, make sure that you always begin by checking, how trustworthy the source of your information is. General tips found on social media can never replace a personal consultation.

Seek advice from debt counsellors

Have you chosen a financing option that has overstretched your financial means right from the start, are you in difficulties due to changes in your personal circumstances, have you had to incur considerable additional expenses for unexpected repairs to your home or are you experiencing hardship due to the current increase in prices for food and energy? There are many reasons why people have serious difficulties financing their property. Anyone already barely able or completely unable to afford their instalments or fearful that they might not be offered an affordable renewal or refinancing loan should seek advice as early as possible. Assistance can be obtained, for example, from consumer centres or state-recognised debt counsellors who can be contacted at many non-profit institutions and charitable associations. We recommend that you prepare a strategy with the help of a debt counsellor and use this as a basis for a discussion with your lender as early as possible.

Steer clear of online loan offers that look straightforward at first sight

Numerous offers can be found online that promise consumers straightforward loans, regardless of their financial circumstances. These offers are often aimed explicitly at consumers no longer able to service their property loans. We advise extreme caution when dealing with such loan offers, as they are usually the work of fraudsters. Instead of a loan, consumers using such websites often receive invoices for services that were never rendered to them or they are contacted by dubious loan brokers.
BaFin regularly gains knowledge of operators of such lender websites which do not have authorisation from BaFin to conduct credit business. The consumer centres also explicitly caution against scammers with dubious lender websites.

Keep financial damages to a minimum

If you are no longer able to continue financing the loan for your home, we advise that you try to keep the financial damage to a minimum. This is also in the interests of the lender. In such cases, an attempt is often made to sell the object by way of a private sale at the best possible price rather than by way of foreclosure.