What is a property loan?

A property loan is a loan from a bank, a German savings bank (Sparkasse), a German building society (Bausparkasse) or an insurance company. It is usually used to buy or build a house or apartment. With a property loan, the lender and the borrower enter into a long-term commitment. This is reflected in the German land charge (Grundschuld) entered as collateral in the land register (Grundbuch) and in the particular type of loan.

What is meant by a loan secured by a land charge or mortgage?

In Germany, the lender usually grants the loan subject to the provision that a land charge or, less common, a mortgage (Hypothek) is created and entered in the land register of the property being financed. This is known as a loan secured by land charge or mortgage.

The land charge (or mortgage) secures the lender far-reaching access rights to the property, i.e. the plot of land, the house or apartment including accessories. Provisions are usually made that enable the lenders to pursue compulsory enforcement (Zwangsvollstreckung) on the basis of the land charge if the borrowers

• default on the payment of the loan instalments in a certain amount,
• are insolvent or
• have had insolvency proceedings opened in respect of their assets.

The enforcement, i.e. the enforced auction (Zwangsversteigerung) or receivership (Zwangsverwaltung), can be initiated quickly. The borrowers are usually obliged to make a declaration at the time the land charge is created in which they submit themselves to immediate compulsory enforcement. This means that, if one of the agreed conditions is met, the lenders may pursue compulsory enforcement directly on the basis of the land charge in respect of the property including accessories to the plots of land.

This is also the case with a mortgage agreement. Under German law, a mortgage differs somewhat from a land charge. But the consequences in the event of compulsory enforcement for you as a borrower are more or less identical.

What types of property loans are there?

Loans with interest rate fixation or with variable interest rates

For property loans, the interest rates are usually fixed for periods of 5, 10 or 15 years. The term used for this is interest rate fixation in German called Sollzinsbindung, Zinsbindung or Zinsfestschreibung. In recent years, there has been an increase in agreements with interest rate fixation periods of 20, 25, 30 or even 40 years. However, property loans are also offered with variable interest rates that are tied to the development of a particular reference interest rate.

Annuity loans or maturity loans

Property loans must usually be repaid in invariable monthly instalments, or annuities. The instalments comprise the interest payments and the repayments of principal. By making regular principal repayments, the loan principal decreases. As a result, the interest share of the monthly instalment continuously declines. At the same time, the share of the principal repayments increases in the amount of the interest saved as a result of the gradual reduction in the loan principal. Such property loans are also known as annuity loans (Annuitätendarlehen).

Other examples of property loans are maturity loans (endfällige Festdarlehen) that usually form part of a combination product. These are fixed loans in combination with a redemption substitute product (Tilgungsersatzprodukt) such as an endowment life insurance, a Bauspar contract or a fund savings scheme. With maturity loans, the borrowers pay only the interest on the full amount of the loan during the term of the loan. They do not make any repayment of principal. The borrowers have to repay the entire amount of principal all at once at the end of the term. If the maturity loan is not aligned with an expected windfall at the end of the loan term, borrowers must not only make the interest payments during the term but must also take out a further savings product, known as a redemption substitute product (Tilgungsersatzprodukt).

Residual debt loans or full redemption loans

Borrowers can take out residual debt loans (Kredite mit Restschuld), in which an amount of debt remains after expiry of the agreed interest rate fixation period. There are two ways in which to redeem these loans:

• The borrowers repay the loan and pay back the residual amount from their own funds.
• The borrowers sign an interest rate adjustment agreement, in other words a follow-up financing agreement in which new loan conditions are agreed for the residual amount while the lender remains the same. The borrowers may also reschedule the debt by signing a new loan agreement with another lender.
  

Borrowers can also take out loans in which the principal is repaid in full after the contractually agreed interest rate fixation period. These loans are known as full redemption loans (Volltilgerdarlehen). It is not uncommon for consumers to need several follow-up financing agreements until they have completely repaid the loan principal.

Forward loans

Many lenders offer borrowers the chance to agree new fixed interest rates long before the current interest rate fixation period has expired. These are known as forward loans. In some cases, forward loans can be signed up to five years in advance.

What factors determine the level of interest rates?

Three factors are initially decisive in determining the interest rates that are offered to you:

• the current interest rate at the time you sign the loan agreement over which you have no influence,
• your creditworthiness and
• your real estate project.

As part of the credit worthiness assessment tender lender examines nyour debt-servicing capacity, i.e. whether you can be expected to make the future interest and redemption payments on the property loan as scheduled from your current earnings. The assessment must also take into account future fluctuations in earnings that are likely to occur. In addition, the lender examines your debt situation in general

As regards your real estate project, the lender examines the mortgage lending value (Beleihungswert) of the property to be financed and the loan-to-value ratio (Beleihungsauslauf). The mortgage lending value is the value of the property calculated by the lender according to certain pre-defined procedures. It should not be confused with the current/market value.

In a next step, the lender and the borrower negotiate the loan conditions.

Lenders demand somewhat higher interest rates for longer fixed interest periods. Borrowers might also have to pay higher interest rates for agreements that offer them greater flexibility in the repayment of the loan, for example the right to make special redemption payments or the possibility to change the principal payments during the fixed interest period.

For forward loans, an interest premium must be paid for every month until the end of the current fixed interest period and until the continuation of the loan at the conditions of the forward loan. Depending on the lender, this premium can vary in amount.

The interest rate in your loan agreement is known as the borrowing rate or nominal interest rate per annum (p.a.). However, the borrowing rate does not provide any indication of the loan costs that you will actually incur. This information is included in the effective interest rate p.a. or the effective annual interest rate. The effective interest rate, which all lenders must calculate using the same formula, also contains the costs associated with the loan.

Please note: Even a marginally higher interest rate is sufficient to considerably raise the costs of a property loan. This can be seen in the following example based on a loan principal of €300,000 and an affordable amount for the monthly instalment of interest and repayment of €1,575. At an effective annual interest rate of 3.14 percent p.a., the borrower would pay approx. €113,500 in interest and fees until full redemption. The expenses would thus amount to approx. €413,500 in total. At an effective annual interest rate of 3.35 percent p.a., the borrower would pay approx. €125,500 in interest and fees until the loan is paid off. Despite an only marginally higher interest rate, the expenses would amount to approx. €425,500 in total, a difference of around €12,000. For the borrower, this would mean paying the same instalment for a further approx. eight months.

What are the risks of a property loan?

The borrower should be aware of the following risks during and at the end of the fixed interest period or term of the loan:

Follow-up financing

If follow-up financing is required, a follow-up agreement is signed at the conditions currently offered on the market. If interest rates for property mortgages have risen since you signed your original loan agreement until the time your follow-up financing agreement is reached, you might have to pay higher interest rates from then on. A loss in the mortgage lending value of the property incurred during this period can also lead to higher interest rates for follow-up financing.

Loss of the property as a result of enforced auction

It is important that you pay the contractually agreed loan instalments on time. If you find yourself in a difficult life situation, for example as a result of illness, unemployment or divorce, you might no longer be able to afford the monthly instalments for the property mortgage loan. If the worst comes to the worst, the lender might pursue compulsory enforcement on the basis of the land charge (or mortgage), in other words enforce auction of the house or apartment.

Penalty for early termination of a current loan in the event of sale

If you sell a property financed on the basis of a fixed interest loan before the fixed interest period expires, you might only be able to redeem this loan if you pay a penalty for early termination. This penalty enables the lenders to compensate their loss of interest incurred as a result of the premature sale.

Loss in the value of the property

If you wish to sell your house or apartment, the proceeds from the sale might turn out to be lower than the loan principal that has still to be repaid. This can be the case particularly with new houses, overpriced properties or overpriced new constructions.

How can I calculate how much a loan will cost me and whether I can afford it?

We recommend that you prepare a detailed evaluation of your financial means. Do you have any funds of your own and, if so, how much do you have (see info box)? How much could you afford monthly to pay off a loan over a long-term period?

Based on the own funds and the acceptable monthly burden, you can calculate how much a lender is likely to grant for a property loan. Online loan calculators can be used to help you make these calculations. Alternatively, you can ask a loan broker, bank, Sparkasse, Bausparkasse or insurance company to provide you with a first estimate. These three parameters – own funds, the expected amount of borrowed capital (see info box) and acceptable monthly burden – give you an approximate framework with which to estimate how much you can afford in normal circumstances. Many useful tips and links for calculating your own funds and acceptable monthly burdens can be found, for example, on the German consumer centre website.

You could broaden your options by making use of state promotional programmes. Information on promotional programmes and the pre-conditions and deadlines for making applications are offered to you during the consultation on your property loan. But it can be useful to gain an idea beforehand of the programmes being offered.

Where can I find information on loan offerings?

Information can be obtained from all lenders, i.e. banks and Sparkassen, insurance companies and Bausparkassen. Other sources of information are loan brokers (property loan brokers), including online loan broker portals.

You can also obtain advice from all lenders and property loan brokers. The statutory requirements that must be fulfilled in order to provide advice on property financing are high. Advisors making individual recommendations for property finance projects are required to gear their offers to your needs and do justice to your 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.

What information must the lender provide me with?

Before signing the agreement, the lender must provide you with a comprehensive information sheet that contains data on, for example, the type of loan, the effective annual interest rate, the borrowing rate, the amounts to be paid and due dates of the individual partial payments and an example of a loan redemption plan. The agreement itself must contain further information, for example on all the other terms of the contract and the possibilities of termination.

May I terminate and prematurely repay my property loan?

You may terminate loans with an interest rate fixation period of more than ten years after the ten years following full disbursement of the loan have elapsed or after a new interest rate agreement has been reached. To do so, you must observe a six months’ notice period. However, the ten years must have elapsed first before you submit your notice of termination and after this, the termination notice of at least six months must be observed.

Loans with an interest rate fixation period of up to ten years may not, in general, be prematurely terminated before expiry of the interest rate fixation period. However, a termination right is deemed to exist if the customer has an interest in using the object serving as collateral for the loan for another purpose (for example if the object is sold or furnished as collateral elsewhere). The lender is entitled to demand a penalty for early termination (Vorfälligkeitsentschädigung). All other circumstances which, from the customer’s perspective, make a premature repayment of the loan appear possible or necessary (for example in the case of an inheritance, a lottery win, unemployment, exploiting a slump on capital markets (to the customer’s advantage)) but which are not connected with the liquidation of the collateral object do not constitute a termination right. This does not rule out the possibility that lenders agree to a premature repayment in such a case. However, the customer has no claim to this. If lenders do consent to the premature repayment, they will insist on the payment of a penalty for early termination.

In the case of a variable-rate loan, the borrower may terminate the agreement by giving three months’ notice.

May the lender terminate my property loan?

The lender may only terminate a property loan with a fixed term if there are important reasons for this. The lender could have a special termination right if the customer’s economic situation has deteriorated considerably, if the customer is in arrears on the payment of the loan or if the mortgage lending value has deteriorated significantly. However, these aspects must be examined closely on an individual basis.

If, due to a deterioration in your economic situation, you are no longer in a position to pay the monthly loan instalments, we advise you to contact the lender immediately, explain the problems and seek a solution together.