Follow-up financing
A follow-up financing generally refers to financing that is taken out in connection with an existing loan. There are two types of follow-up financing: the first describes a change or adjustment of the interest rate of an existing loan after the end of the fixed-interest period. This case is the so-called "indirect follow-up financing." The "direct follow-up financing" is financing that is taken out or applied after the term of a loan agreement has expired—for example, to repay the remaining outstanding debt (debt restructuring).
What is a follow-up financing?
Mortgage financing, or property financing—in short, financing your own home—is usually long-term financing.
Homes are often financed with equity that the homeowners have saved in advance or that they provide through their own work during the construction phase. In addition, there may be funding or subsidies available if certain conditions—such as building a low-energy house—are met and can be documented.
However, there is usually still a gap remaining in the homeowner’s budget to finance the property. This gap is typically closed with a mortgage loan. Mortgage loans are characterized by the fact that the borrower receives a loan and, in return, the liability to the bank that provides the loan is registered in the land register. This makes the property collateral for the bank if the borrower can no longer meet their monthly payments. A mortgage loan is usually granted as a long-term loan that can have a term of ten, 15 or up to 25 years.
This loan term indicates how long the bank is bound to the interest rate in effect at the time the loan is granted. The mortgage loan is therefore subject to an interest-rate lock-in. If the general interest rate falls during the term of a mortgage loan, borrowers have the right, despite the interest-rate lock-in, after a certain period to have the contract adjusted downward to the newly prevailing market conditions.
Because of the often large amount borrowed at the start of a mortgage loan, the liability is frequently not fully repaid at the end of the loan term. In this case there remains a residual debt that the homeowner could pay off in full at the end. However, this amount is often still comparatively high. In addition, the homeowner would have to save this final amount in addition to the regular interest and principal payments required to service the mortgage. For most private homeowners, this is too much. A follow-up financing is therefore a practical solution. In short, a follow-up financing is a loan taken out to repay the residual debt of an originally taken mortgage or property financing. In other words, a follow-up financing is a loan taken at the end of a mortgage to settle the remaining debt of the original financing.
Follow-up financing at the end of the loan term
If, for example, a mortgage loan runs for ten years, the lending institution or bank that granted the loan will contact the homeowner in good time before the term ends. The aim will then be to conclude a new loan with the homeowner at updated terms—a so-called follow-up financing.
We illustrate the principle of follow-up financing with a small example:
If the borrower took out a loan of €100,000 for which they must pay 5% interest per year and that is being repaid at 1% per year, their annual burden is 6% of the initial loan amount, which corresponds to €6,000.
After ten years of term, suppose this initial amount has been reduced by annual repayments and any special repayments to €70,000. That is then the amount that must be covered by a follow-up financing.
Assume the borrower still wants to pay a maximum of €6,000 per year for this loan amount; the effective market interest rate may have risen to a maximum of 7.5% (rounded) if the monthly repayment is to remain at 1%.
Conversely, it could also be that lending rates remain at 5%. With a repayment rate of 1%, this would result in an annual burden of 6% of the outstanding loan amount. In this example that would be 6% of €70,000, so the annual burden would only be €4,200.
The new financial leeway of €1,800 could be used by the homeowner to increase the low repayment rate from 1% to, for example, 3.5%. That would bring the annual burden to a total of 8.5%, which on an initial loan amount of €70,000 would correspond to an annual burden of €5,950. This would keep the homeowner’s payments approximately at the previous level, but due to the higher repayment and the associated interest and compound interest effects, the loan would be repaid significantly faster than with the originally planned 1% repayment.
Follow-up financing during the loan term
To avoid relying entirely on luck with mortgage financing, it is advisable for borrowers to keep an eye on the interest rates that lenders charge for a follow-up financing. Depending on the agreed term of their mortgage, the interest level can change with market conditions and may be lower than the interest rate fixed at the time the original mortgage was agreed.
Therefore, a debt restructuring—the taking out of a new loan on improved terms to repay an ongoing financing—can make sense. As a rule, it is generally possible to terminate a loan early and replace it with a new loan on adjusted terms (debt restructuring), usually in exchange for a surcharge on the interest rate.
The residual debt is therefore transferred from the original mortgage to the new loan by taking out a follow-up financing early. The possibility of debt restructuring is illustrated by the following example:
The initial terms are the same: the loan amount is €100,000, the interest rate is 5%, the repayment rate is 1%, so the annual burden is €6,000.
After eight years—i.e., two years before the end of the mortgage’s term—the remaining mortgage balance after repayments and special payments is €80,000. If the general interest level falls during that time—for example, to 3%—two options are available to the homeowner:
- Hope that the rates are still that low in two years when the loan expires, or
- Seize the opportunity and not rely solely on hope. In this case they can ask their bank in advance for a follow-up financing that begins, for example, 20 months before the actual end of the loan term.
Banks generally accept this under certain conditions. It is common market practice for banks to charge a surcharge of 0.001 percentage points on the interest rate for each month that the follow-up financing starts earlier, with six months not being counted.
In the example of a follow-up financing that begins 20 months before the end of the term, 14 months would therefore be counted for the interest increase of 0.001 percentage points—at a market rate of 3% the new loan would thus be charged at 4.4%. This interest rate is lower than that of the original loan and gives the homeowner the advantage of being certain for another ten years to have annual payments that are within their means.
Follow-up financing via a forward loan
For follow-up financing of a completed mortgage, it is often possible to take out a forward loan to repay the remaining debt. A forward loan is a form of annuity loan used in real estate financing. It is characterized by its fixed interest-rate period. The forward loan is only disbursed to the borrower after a certain lead time and not immediately at the time of contract signing—hence the name ("forward" meaning "ahead").
The forward loan is subject to an interest-rate lock-in. By concluding a forward loan, the borrower secures a fixed interest rate that remains the same over the entire loan term. If one expects that the interest level will rise over the coming years, one benefits from the fixed rate of the forward loan because the interest agreed at contract signing remains unchanged over the entire term. In the case of falling interest rates, however, the fixed rate can turn out to be a disadvantage. A subsequent follow-up financing at a lower rate is no longer possible once a forward loan has been contractually concluded. The lender or bank issuing the forward loan would demand compensation if the agreed loan is not taken up.
Follow-up financing - comparison of terms
As with other loans, it makes sense to conduct a comprehensive comparison of different providers and the terms they offer before arranging a follow-up financing. The many available offers often differ in loan amount, term and fixed-interest period. The terms for the right loan are, of course, closely linked to personal wishes and possibilities; many comparison portals therefore offer individual calculators. But even a good calculator cannot replace an individual and personal consultation. An online comparison or the use of a calculator can, however, provide a first rough overview of available follow-up financing options.
For a personal and free offer, the MAXDA team will be happy to assist you