The land charge

In the context of construction financing, prospective borrowers are almost always confronted with the term land charge. It should be clear to anyone involved that this has something to do with securing construction loans. But what exactly does the term mean and what special relationships exist between a land charge and construction financing? This article describes the land charge with its effects and particularities in more detail.

What is a land charge?

The land charge is a legal term from the German Civil Code (BGB) that describes the real right to derive payment of a sum of money from a property or a right equivalent to land (homeownership). However, no assignment to a specific claim takes place; the assignment is only to an addressee (the secured party). By entering the land charge in the land register, the secured party thus obtains the right to claim a sum of money equal to the land charge. In practice, this security right is almost always used to secure construction financing or similar loans.

What is a land charge needed for?

The greatest importance of the land charge is clearly in securing property financing. The object to be financed simultaneously serves as collateral, which is manifested by the land charge. This use as a security land charge normally has the following effects:

• The bank is entered in the property's land register as the secured party.
• The amount of the land charge initially corresponds to the level of the loan debt, but can increase due to land charge interest.
• In the event of payment defaults by the borrower, the bank is entitled to satisfy its claims by forced sale or compulsory administration of the property.

Beyond loan security, there are also some other possible uses for land charges:

Preservation of rank: If the property owner wants to secure a favorable ranking position for a future loan in advance, a corresponding land charge can be created even without an underlying claim. In this case, the addressee is the property owner himself (owner's land charge).

Contribution in kind: A land charge can also be contributed as a contribution in kind to a corporation. Here, too, no loan claim corresponds to this security right.

How is a land charge registered?

The creation of a land charge is subject to a standardized procedure, which can be divided into the following steps:

1. The land charge creation form is prepared

The land charge creation form serves both to create the land charge and to set special conditions for the respective land charge. In practice, the following conditions are frequently found, for example:

• Submission to immediate enforcement: The option to submit to immediate enforcement is, according to §800 of the Code of Civil Procedure (ZPO), a popular means for banks to initiate enforcement against defaulting borrowers as simply as possible. If this clause is included in the land charge creation document, the bank thus holds an enforceable title against the property owner and does not have to sue for it in court.
• Assumption of personal liability: Banks often require, in addition to submission to immediate enforcement, the assumption of personal liability. This abstract promise to pay allows the bank, in the event of a loan default, to satisfy its claims not only from the property itself but, if necessary, also from the remaining assets of the property owner.

2. The land charge is notarized

Although in individual cases a notarized certification may suffice, in practice the land charge is almost always notarized. This is mainly due to special agreements such as submission to immediate enforcement, for which notarization is required according to the ZPO.

3. The notary files the deed with the land registry

By filing with the land registry, the land charge is ultimately entered into the land register.

4. The notary hands over the necessary documents to the creditor

The notary forwards a copy of the deed on the land charge and an updated land register excerpt to the creditor. This completes the process.

To limit the land charge to the loan claim, a so-called security agreement (declaration of purpose) is also concluded, which clearly regulates this. In addition, the borrower and the bank agree in this contract that after repayment of the loan there is a claim for issuance of a deletion consent. As a further provision of the security agreement, submission to enforcement is often explicitly agreed.

Who creates the land charge?

The land charge is always created by the property owner or the holder of a right equivalent to land. After all, it authorizes the secured party to satisfy itself, if necessary, from the property's assets in the form of a forced sale or compulsory administration. In the area of the mortgage, there is a means called the compulsory mortgage, where a land charge can be registered at the instigation of a third party. However, according to §867 ZPO this is only a means of enforcing claims and is only possible if the claim exceeds the amount of 750 euros.

What are the differences between a land charge with and without a certificate?

The land charge is possible in two different variants. In addition to the standard procedure of the certificate land charge (Briefgrundschuld), there is also the possibility to waive the land charge certificate and use only the entry in the land register. The differences are briefly summarized in the following table:

The advantages and disadvantages of the two variants are interdependent. While a certificate land charge can be more easily resold by the creditor, it is significantly less transparent. A certificate land charge can be transferred by handover and a private assignment agreement. The land register remains unaffected, so the transaction is relatively inexpensive. In the past, the owner of the property might not even have been notified. However, this was recently changed by the Risk Limitation Act. With a register land charge this was never possible anyway, since it always requires an entry in the land register.

Note: According to §1116 BGB para. 2, the exclusion of the certificate must be entered in the land register for the creation of a pure register land charge. This therefore requires an agreement between the owner and the secured party. Thus, the standard case is the certificate land charge.

Can multiple land charges be registered on one property?

It is generally possible to register multiple land charges on a property. This is interesting, for example, for construction financings that are partly covered by a home loan savings scheme (Bauspardarlehen). When multiple land charges exist, they necessarily create a ranking order that becomes important in the event of enforcement. A small example illustrates this:

A property was financed with an amount of 150,000 euros, of which 110,000 euros are covered by a conventional construction loan. The remaining 40,000 euros come from a home loan savings loan secured by a second-ranking land charge. Due to the property owner's default, a forced sale takes place, yielding only 95,000 euros. This results in the following payments:

This example simply shows what the ranking of land charges means. For this reason, banks place great importance on obtaining a first-ranking land charge in the property's land register when granting construction financing. Building societies, on the other hand, are often satisfied with the second rank. Because today the assumption of personal liability is very common, banks can also try to satisfy further outstanding liabilities from the remaining assets of the property owner after the forced sale.

What happens when a land charge is terminated?

If property owners can no longer pay the instalments on their construction financing, the bank is entitled to terminate the land charge security. According to §498 BGB, however, two important prerequisites are required:

1. The borrower is in arrears with at least 2 instalments.
2. The overdue amount is at least 2.5% of the nominal loan amount.

In this case, the bank can terminate the land charge, subject to a notice period of 6 months. Only after this notice period has expired does the bank have the option to apply for enforcement.

Land charge and costs

What costs arise when creating a land charge?

Creating a land charge involves certain costs. These are divided into two areas:

1. Costs at the land registry

The land registry charges fees for entering the land charge in the land register. In addition, an extra fee is payable if a land charge certificate is to be issued. Depending on the amount of the land charge, the costs are between 0.25–0.35%.

2. Costs for the notary

The notary's fees for notarization and execution amount to roughly the same as the land registry fees, but notary fees are subject to an additional 19% value added tax.

Since the creation of a land charge is obligatory in most property purchases or when building a house, it is counted together with the notary fees for notarizing the purchase contract as part of the ancillary costs of acquiring a property. Buyers normally calculate 1–2% of the purchase price for this, whereas total ancillary costs can amount to up to 15% of the purchase price.

What are land charge interest rates?

The land charge generally serves as security for the loan amount of the construction financing. In order for banks to cover potentially higher costs in case of default, they usually agree on land charge interest rates, which are entered in the land register together with the land charge. These land charge interest rates do not have to be paid by the borrower monthly; they initially remain a figure on paper. Only in the case of a forced sale do banks have the opportunity through the land charge interest to claim a higher sum for unpaid interest and enforcement costs.

Why are land charge interest rates higher than loan interest rates?

The amount of land charge interest is usually significantly higher than the actual loan interest. Values of 12–20% per year are not uncommon. Such high land charge interest rates primarily serve to protect the bank against unforeseeable and high future claims. Relevant examples include:

• Rising interest levels and higher interest costs due to follow-up financing
• Interest shortfalls in the course of enforcement
• Costs of a forced sale

The following example shows the calculation of land charge interest:

• Land charge: 150,000 euros
• Land charge interest: 15% p.a.
• Land charge interest after 3 years (with compound interest): 78,131 euros
• Land charge after 3 years: 228,131 euros

According to §197 para. 2 BGB, land charge interest expires after 3 years, so the maximum land charge remains constant after 3 years. If a forced sale were to take place, the bank could therefore at most register 228,131 euros as a land charge and claim additional costs.

Note: The land charge interest actually only represents a security amount and is initially not relevant for borrowers. Only in the event of enforcement would the increased land charge become relevant. It should be noted, however, that the creditor is still only reimbursed for his actual costs plus interest. Any surplus from the forced sale must be returned to the former owner of the property.

What costs are incurred when assigning a land charge?

In construction financing, it is not uncommon to arrange the follow-up financing with another bank after the fixed-interest period has expired. This can often significantly reduce interest costs. However, when switching banks, the problem arises that the new bank must also be registered as the creditor of the land charge. Fortunately, assignment of the land charge to another bank is a much cheaper alternative to deletion and re-creation of a land charge. For assignment of the land charge to another bank, only a notarized certification is required, so the costs for deletion and re-registration are avoided. In many cases, owners therefore save money through assignment.

Note: Some banks even cover all land registry costs up to a certain cost limit during debt restructuring. When comparing such offers, borrowers should therefore also pay attention to this when choosing their new construction financing.

What special forms of land charge exist?

In addition to the variants of land charge with and without a certificate already described above, some other special forms are distinguished. There are different criteria for differentiation:

Distinction by purpose of use

One way to distinguish land charges is clearly by their use. In practice, the following two forms in particular exist:

Security land charge: A security land charge is the standard case, as it is used as security for a loan. If the construction financing is not repaid in accordance with the contract, the bank can satisfy its claims from the property. This usually leads to the forced sale of the property. A security land charge is always created in practice in conjunction with a security agreement in order to limit it to the respective loan claim.

Isolated land charge: The isolated land charge is not created to secure a loan, but initially without any apparent reason. Since a land charge is a non-accessory security, it does not have to be linked to a claim. It can also exist completely independently. The purpose of such an isolated land charge is usually to secure a favorable rank for a later loan as a property owner or to contribute the land charge as a contribution in kind to a corporation. It can also be an interesting option as a gift to heirs. In practice, however, this variant plays a very minor role.

Distinction by the addressee

Land charges are also distinguished by the addressee:

Owner's land charge: An owner's land charge is a security right registered in the name of the property owner himself. In many cases this is also an isolated land charge, so the reasons for such a creation also lie in securing rank, a gift, or contribution to a corporation. An owner's land charge also arises when the loan debt decreases below the value of the security land charge due to repayment.

Third-party land charge: The third-party land charge represents the standard case, as here the land charge is registered in favor of a third party. This third party can benefit from the real right to claim a sum equal to the land charge. The security agreement also limits this real right to a specific claim and stipulates the modalities from which the land charge may actually be enforced. Third-party land charges are often security land charges.

Collective land charge: A collective land charge is a special case, as it is a security right distributed over several properties with different owners. According to §1132 para. 1 BGB, the rules on joint debts apply in this case. Thus, the creditor has the choice to satisfy his claim from only one property or from all properties. If the creditor thereby places a greater burden on one property owner, that owner has a claim for reimbursement against the other property owners within the collective land charge. He thus acquires the registered land charges up to the amount of his reimbursement claim. A collective land charge is always marked by a collective liability note in the land register.

Cancellation of a land charge

As a non-accessory loan security, a land charge can continue to exist even after the loan claim has long been repaid. Nevertheless, the property owner has a claim for restitution after repayment of the construction financing. Thus, the land charge is either reassigned to the owner (re-assignment), automatically cancelled by the bank, or there is a claim for issuance of a deletion consent. The last solution is favored by many banks and is usually recorded in the security agreement.

How does cancellation of a land charge work?

Cancellation of a land charge is relatively straightforward but also involves certain costs. The following steps are required:

1. The creditor (usually the bank) issues a deletion consent and thereby confirms that the claim no longer exists.
2. The property owner takes the deletion consent to the notary.
3. The notary contacts the land registry and thus arranges the deletion of the land charge.

Note: If a land charge certificate exists, it must also be presented to the land registry. In case of loss of the land charge certificate, an expensive court procedure may be required to cancel the land charge.

Is cancellation of a land charge always advisable?

The question of whether it makes sense to cancel a land charge arises mainly because costs are involved. Both the notary and the land registry charge fees for cancellation, similar to those for creating a land charge. However, since the land charge as a non-accessory security does not automatically expire with repayment of the loan, it could simply remain in the land register. The following lists arguments for and against cancellation:

Possible reasons for cancellation

The reasons for cancelling a land charge are not numerous. However, there are situations in which this step makes sense:

Sale of the property: Buyers of a property often want to see a "clean" land register. A land charge could be an aesthetic encumbrance and cause price reductions or at least give a potential buyer arguments for negotiating the price.

Protection against risks: In the past there was a risk that land charges were sold by the original creditor to a new creditor. If the new creditor could prove that he knew nothing of the security agreement (acquisition in good faith free of defenses), he had the possibility of immediate enforcement. In this case, the borrower was left only with a claim for damages against the original creditor. Meanwhile, the legislator has put a stop to this possibility with the Risk Limitation Act. Through the new paragraph 1a in §1192 BGB, an acquisition in good faith free of defenses in this form is no longer possible.

Reasons against cancellation

There are several arguments against cancelling a land charge. These include: Costs: Since cancellation of a land charge always involves costs, it should only be carried out when urgently necessary. The costs for notary and land registry can amount to about 0.4% of the land charge.

Reuse: If the bank has issued the deletion consent, there is nothing to prevent keeping the land charge. If you later want to take out a modernization loan or other financing, you then have an attractive loan security. In addition, you save the costs of creating a new land charge, since it can then simply be cost-effectively assigned to the new creditor.

Land charge vs. mortgage - what are the differences?

When concluding construction financing, you will in many cases still come across the term mortgage loan. The reason for this designation is that construction financing in the past was often secured by a mortgage. Meanwhile, the land charge has at least almost completely replaced the mortgage in Germany. But what are the actual differences between a land charge and a mortgage? The differences are explained in the following table:

Banks prefer the land charge today mainly because it is much easier to handle. In the event of payment defaults, no lengthy legal proceedings are necessary; the independent land charge with submission to immediate enforcement is an enforceable title. For borrowers, the main advantage is that the land charge can still be reused as loan security after repayment.

Our conclusion on the land charge

The land charge represents a security right that is today mainly used to secure construction financing. It has largely replaced the mortgage in Germany and grants the creditor a real right to demand a specific sum of money from a property. Through a security agreement, the land charge is limited to the loan claim and it is also stipulated that enforcement may only take place if loan instalments are not paid. In general, land charges can also be created for other purposes, but this is very rare in practice.