Basics of interim financing
When you prepare a needs calculation for a planned financing, it is usually immediately apparent whether all planned financing sources will be available in full at the time they are needed. If this is not the case, interim financing comes into play. Interim financing is a short-term loan until the final loan from the financing bank is paid out. However, an interim financing is always tied to a specific purpose.
When is interim financing needed?
Any financing can be combined with various sources of funds. Interim financing is relevant for entrepreneurs as well as for private individuals who may need it for real estate financing. Normally, a construction financing rests on two pillars: equity and debt capital. However, this equity is not always available to the homeowner in full and at the time required. For example, there can be a waiting period for the payout of a saved Bauspar contract if not all conditions for allocation have yet been met. Or the homeowner may have invested his equity in long-term investments that only mature in one or two years. These can be, for example, savings contracts or life insurance policies. A similar situation occurs if the homeowner already owns a property or possesses land to be sold. If these assets have to be sold quickly, one usually has to expect a below-average selling price. In such cases, interim financing steps in until the transfer of ownership is completed. This gives the homeowner the necessary flexibility to obtain a good price for his property. The same applies if the equity needed is tied up in a securities portfolio. Quickly liquidating it can also lead to a loss. Interim financing is also an option here to wait for a better time to sell the securities. In all these cases, interim financing helps to avoid restricting one’s ability to act. Of course, a consumer or purchase loan can also be pre-financed with an interim loan. For example, if a new car is purchased but the fixed-term deposit is only available in a few months, an interim loan can be used for flexible financing.
How is interim financing applied?
An interim financing in the context of a mortgage loan helps the homeowner bridge a financing gap. This gives him, as the borrower, enough time to convert his real estate or investments into liquid funds. There are different examples: it may be that the homeowner owns a condominium and now wants to buy a house. The sale of the condominium can only take place after the tenant has moved out. This is sensible so that any cosmetic repairs can be carried out. These renovations alone often lead to a higher sale price, which the owner does not want to forego. Or the owner of a condominium builds his new home with a property developer. In this case, the full purchase price is not due at once, but payments are made in stages as the developer’s work is completed. Thus, it can happen that the purchase price is due in five installments, while the negotiated credit line with the bank is already exhausted after the second partial payment. Interim financing then kicks in for the remaining payments. The borrower can thus react flexibly to payment demands.
To obtain an interim loan, an interim financing agreement must be concluded with the bank that will provide the final financing. This contract specifies the loan amount. This amount is made available to the borrower until the liquidity of his own funds is restored. Of course, the borrower must pay interest for this period. The conditions for an interim loan are generally higher than for a mortgage loan. Some banks also charge processing fees. Due to the higher interest burden, it makes sense for the borrower to use an interim loan only for a short term. During the term of this type of loan, repayment of the loan principal is usually not possible; only the accrued interest must be paid. The lender is naturally interested in ensuring that repayment of this interim loan is guaranteed. The borrower should be legally bound to the bank until the full disbursement of the mortgage loan, i.e. until his already saved but not yet available equity is paid out. This may lead to the assignment of payout claims to the lending institution. It is also possible for the mortgage lien to be registered in the land register. This mortgage lien can be registered on both existing property and newly acquired property. The lending institution providing the interim financing thus has security if unforeseen payment difficulties arise. This way the lender does not take on undue risk when providing temporary financing for an asset.
What should be considered with interim financing?
In principle, interim financing offers a great advantage to the homeowner in construction: a temporarily limited financing gap can be closed and the planned project can be completed financially without problems. The only drawback is the higher interest rate charged by the financing provider for this period. However, many credit institutions have room for manoeuvre in their interest rate policy, which should definitely be used. They may offer a lower interest rate, for example, if the homeowner can already present a potential buyer for the property to be sold. An already concluded purchase contract is ideal for this. In this way, the lender has the guarantee that the interim-financed amount will be repaid in full. However, every borrower must also be aware of the risks an interim loan can entail. It may turn out that the sale price of the property cannot be achieved. This should be discussed with the lending institution in advance and alternatives for the overall financing should possibly be considered. Or the agreed period for the interim financing expires without the equity being available because it is still tied up elsewhere. Consequently, the interim financing must be extended. This usually leads to a change in the interest rate. That means the interest rate risk increases and the calculated interest burden can quickly exceed the homeowner’s budget.