Legal protection for property financing

A property financing is a transaction that involves large sums of money. In addition, the particularly long-term cooperation between borrowers and financiers means that substantial costs in the form of interest for construction financing accrue over time.

For this reason, the legislator has issued many provisions for consumer protection regarding construction financing for private builders or purchasers of real estate, so that consumers are not, among other things, burdened with unreasonable interest rates for construction financing. For example, the property purchase and the creation of mortgage rights must be notarised.

Contracts for real estate loans are also subject to additional consumer protection rights such as a right of withdrawal. If the borrower falls into arrears with interest payments or instalments, they are, not least, protected by the Risikobegrenzungsgesetz against too-rapid termination of the credit by the lender.

Interest rates in construction financing

The level of the interest rate for loans always depends primarily on the lender’s risk of getting the money back. The rule is that the interest rates for construction financing are higher the higher the risk. However, in construction financing the risk is comparatively low.

A property offers particularly much security if it is located in a good area, is in good condition and, for example, can be easily let or sold. This security, however, only exists if these factors are assessed realistically.

Because of these particularities, not only are the financing mechanisms for construction financing very specific, but financiers must also be particularly specialised in construction financing in order to be able to offer good interest conditions. Typical institutions for construction financing are credit institutions such as banks, savings banks, building societies but also institutional investors such as life insurance companies or other capital investors.

Credit brokers such as MAXDA also play an important role in arranging and providing construction financing; often, due to their advisory activities, they not only connect borrowers and lenders but also help optimise loan structures and, last but not least, the level of interest and instalment burdens. To a lesser extent, there are also private lenders for construction financing outside the commercial sector. These include, for example, employers who grant low-interest employee loans for construction financing.

There are also funding institutions of the federal states or the federal government, such as the Kreditanstalt für Wiederaufbau. Since the real estate industry has a strong influence on the overall economy and construction financing constitutes a large proportion of all loans in Germany, it is in the interest of the state to accelerate or dampen the real estate market through certain funding or restraining measures.

Therefore, in connection with the financing of real estate, special tax treatments are repeatedly put into effect that are intended to achieve the respective political goal of promoting or slowing the construction and real estate cycle. Politics often targets the interest rates for construction financing, for example by promoting building activity through the tax deductibility of interest burdens.

Interest rate forecasts: fixed or variable rates for construction financing

The development of interest rates over the usually long term of a construction loan, which runs for 20 or 25 years or even longer, is difficult to estimate. In the short and medium term, however, there are ways to make at least somewhat realistic assessments of interest rate trends, since the interest rate development for construction loans depends on the monetary policy of the European Central Bank.

From these so-called key interest rates are derived the rates agreed for loans between banks. The development of the Euribor interbank rate is particularly important here. The Euribor indicates a rate at which banks lend money to each other. Many interest-rate calculations by construction financiers are based on this rate.

If the central bank raises the interest rate level, the rates for interbank loans also rise, which in turn increases the interest rates for builders and property buyers, and vice versa. The development of the ECB’s key interest rates can at least be estimated as a trend reasonably reliably if one considers the overall economic development. The ECB’s interest rate decisions are primarily aimed at maintaining price stability.

To keep the value of money stable, the central bank must intervene in economic upturns to prevent an excessive increase in the money supply and thus inflation. To do this, the ECB restricts the money supply, for example by raising the key interest rates. This makes borrowing from the central bank more expensive, which in turn raises the cost of loans between banks and, ultimately, the interest rates for construction financing.

If the economy weakens, however, the ECB lowers the key interest rates to stimulate the economy again. The central bank’s loans thus become cheaper, and in the end the interest rates for construction financing also fall. Because one can estimate the overall economic development at least for some time with a certain degree of confidence, it is therefore possible to foresee a trend for the ECB key interest rates and thus for construction financing over that period.

However, since it is not possible to make reliable economic forecasts over very long periods, the long-term development of interest rates cannot be predicted with sufficient accuracy.

Construction financing interest rates via annuity loans

One of the most common loan types for construction financing is the annuity loan. Exceptions to this include, for example, newly concluded building savings contracts (Bausparverträge). There the entire building savings amount is pre-financed until allocation. Repayment portions flow as savings contributions into the building savings contracts and the interest for construction financing is calculated on the entire pre-financed building savings amount. Only upon allocation of the contract does a building savings loan become an annuity loan.

Also in the case of bridge financing in connection with construction financing, there are often interest-related peculiarities, where the bridge loan is made interest-only and only interest for the construction financing has to be paid. With an annuity loan, each repayment reduces the loan and thus the capital to be financed. Thus, with each repayment instalment during the financing, the interest burden also decreases.

When the repayment of an annuity loan begins, the interest portion in the usually monthly instalment is relatively high. Little principal has been repaid and the borrowed capital is very high, which means a higher interest burden. Over time, however, the capital subject to interest decreases due to the ongoing repayments. The ratio between repayment and interest portions then shifts.

The longer an annuity loan runs, the lower the interest portion and the higher the repayment portion of the regular instalments. Without agreeing a fixed-rate period, the instalments of an annuity loan are variable because of fluctuating interest rates.

To make the long-term burdens of a construction financing more predictable, however, one can conclude a construction loan with a fixed interest period. An annuity loan with fixed interest conditions offers the great advantage that the interest and repayment payments remain at the same level at least during the fixed-rate periods, which makes the burdens for that period reliably plannable. The longer the fixed-rate period chosen, the higher the interest rate.