Managing Real Estate Loans in a Rising Interest Rate Environment: Options and Considerations

In recent years, home builders and homebuyers have had fantastic credit conditions. The main reason was the European Central Bank’s historic phase of zero interest rates from 2016 to July 2022. Since then, the key ECB interest rate has risen sharply – and with it real estate interest rates. If you have to extend your old loan from the portfolio, you risk having to pay significantly more for it.

Real estate loan: Extension of the term and reduction of the repayment installments

Simply repay or reschedule a construction loan with high residual debts, many do not have these options. It is therefore worthwhile to approach the bank before the old fixed-interest period expires. Except for the sharp rise in interest rates, the new follow-up financing can be cheaper than the old initial financing. After all, debtors have already repaid a number of things in the meantime. Because of these repayments made, the new repayment rate may be reduced. For example, instead of three or four percent, only two percent of the remaining debt will be repaid each year. The monthly rate falls accordingly, which creates space for a higher interest burden, which can at least partially be offset.

The disadvantage is the extension of the total term until the property finally becomes debt-free. A change in amortization is therefore a double-edged sword. The advantage is that the short-term monthly burden decreases, making the debt more sustainable. By extending the term, however, debtors end up paying more interest over the years.

Mortgage: Changing the bank can cause high additional costs

There are numerous platforms on the Internet that advertise cheap follow-up financing. Because at first glance it is often already clear that your own bank is often no longer as generous with follow-up financing as it was at the beginning with the interest rates. Due to the registered mortgage in the land register, which migrates from one bank to another when you change banks, you have to budget for several hundred euros in additional costs for this pledge exchange. In addition, the new bank must first carry out a full credit check, which does not always go smoothly.

Some difficult financing conditions for new customers

The EU and the European banking supervisory authority have tightened the financing conditions for real estate loans in recent years, which primarily affects new customers and less so existing customers. Building loans should now be repaid in full before retirement age if possible. Lending solely on the basis of the value of the property has even been banned, although this used to be quite common.

In addition, the house bank can include other criteria for the loan when evaluating the project, since it has known the customer for longer and better (so-called internal rating). The bank advisor could therefore take the extension of the real estate loan as an opportunity to sell additional financial products, such as a home savings contract.

Is it better to continue with a home savings contract or just continue with an old loan?

In times of rising interest rates, building society loans are increasingly being offered, which promise a low-interest loan for the remaining term after a savings phase. The catch is the closing fee, which is usually 1 percent. This usually refers to the entire contract amount, regardless of whether the building society loan is later used at all. The presumed interest advantage can therefore already be lost when the contract is concluded. In addition, the home loan and savings contract increases the overall monthly burden of the loan installments that are already available and thus makes the current real estate financing even more expensive. So it would be better to avoid it. As long as there are no debts and it is only about capital formation before buying a property, building savers can make sense.

Is it better to create special repayments or other reserves?

Another possibility is special repayments, which can even be made every year for many real estate loans, but at the latest at the end of the fixed interest period. This does not necessarily reduce the monthly burden, but the term of the loan agreement up to the last installment can be significantly reduced. It doesn’t help that much for the moment, but it pays off in the end if the loan is paid off much earlier.

So if you can afford to put some money aside in addition to the monthly loan installments and save for a special repayment, you remain flexible and are therefore able to cope with any interest rate development in the best case. If you don’t need the money for the real estate loan after all, you can put it into a renovation or energy-saving renovation of the property, which is currently very topical in addition to the already higher interest rates.

Special case: repayment with capital life insurance

Although special repayments, building society contracts and other cash reserves reduce the term and long-term interest burden, the monthly payments are not necessarily smaller. Some homeowners have pledged their life insurance for their real estate loans and thus have the option of later paying off their property in whole or in part with the insurance sum due. In the phase of low interest rates that lasted more than a decade that is now behind us, however, the interest rates on insurance products were much worse than originally assumed. With the currently rising yields, this form of real estate financing could perhaps become more attractive again, but there is always an increased risk associated with it. In the worst case, the private pension plan is gone and the house is still not paid off.