Experts are certain that a trend reversal in construction financing interest rates has been initiated. This also increases the residual debt risk. Construction interest rates have been rising since the beginning of the year. This means that the highest level since mid-2019 is reached in January. In the meantime, the interest rates are significantly below this limit. Some borrowers with a good credit rating had to pay only o.5 percent interest. Currently, interest rates for loans with 20-year fixed interest rates average 1.4 percent. In the decade comparison this is still favorable though. However, there are increasing signs that further interest rate increases are on the horizon. In order to keep the monthly charges within limits, some prospective borrowers consider lowering the repayment rate for this reason. But is this a good idea?
One indicator of the interest rate turnaround: the yield on ten-year federal bonds
Mortgage rates are closely tied to mortgage bond rates. These, in turn, move in tandem with federal bond yields. Rising bond yields therefore usually also lead to higher construction interest rates. As a guideline, the interest rate for a loan with a ten-year term develops parallel to the yield of the ten-year federal bond – plus 1 percent. As crestfinanz reported in the current newsletter, last week was the first time in almost two years, the ten-year federal bond with a positive interest rate was traded. At the peak, the bond rose to 0.0006%.
As we had already explained in our interest rate comparison interest rate commentary 2022, an increase in interest rates is to be expected in the coming months. However, this is no reason to make a hasty and ill-considered decision, as the expected rise in interest rates will most likely be moderate. Interest rates for a construction loan with a ten-year fixed interest rate are expected to rise to between 1.5 and 1.75 percent during the course of the year. Nevertheless, the level remains low in a historical comparison, because ten years ago interest rates of more than 3 percent were common – and were already considered very favorable at that time.
The residual debt risk if interest rates continue to rise
If the construction interest rates are still relatively favorable and the purchase costs for real estate are still high, the temptation is obvious to realize the dream of your own four walls with a relatively favorable monthly burden. But the monthly charge is a deceptive value. It is much more important how quickly the loan can be repaid. It is advisable not to save on repayments in order to keep monthly bank rates as low as possible. In times of potentially rising interest rates, it is much more important to set the repayment at a high level in order to minimize the residual debt that remains at the end of the term of the interest-linked mortgage loan.
The residual debt always shows the amount that has to be newly concluded at the end of the initial financing with the follow-up financing. This is why the contract design of the initial financing is particularly important. In addition to many contract components to consider, such as flexible adjustments and unscheduled repayment options, there are two factors in particular that minimize your residual debt risk in times of rising interest rates:
- Interest-linked term of the contract: it makes sense to plan the interest-linked term of the contract as long as possible. Financing of at least 15 years is strongly recommended; even longer terms (20 – 30 years) are also possible – also depending on the amount of equity you can contribute to the real estate purchase. It is important to know that banks charge low interest premiums for particularly long-term contracts.
- The initial repayment should be set as high as possible. The repayment rate determines how much residual debt remains at the end of the interest-linked term and can then be financed again with follow-up financing. If interest rates rise, the interest rate for the follow-up financing will then also be much more expensive. Then it can avenge itself not to have used in the low-interest phase the maximum amount for the repayment and thus for the debt reduction. And the residual risk then becomes a real risk.
How new financiers and follow-on financiers can keep residual debt risk low now
- If you already have a current short-term construction financing contract with a low amortization rate, the only way to get out as soon as possible without having to pay money to the bank in the form of a prepayment penalty is to. This allows you to take out a forward loan (usually up to 3 years before the initial contract expires) during the interest-rate-linked term of the initial contract, which secures you the currently still favorable interest rates for follow-up financing. In this forward loan, however, you can then set the repayment as high as possible and the term as long as possible.
- When taking out initial financing, it is advisable to take out the highest possible repayment (5 percent) with the longest possible term (20 years). How to reduce the residual debt risk for follow-up financing. Of course, you have to make sure that the monthly burdens remain within reasonable limits for you. A maximum of 40 percent of the monthly net household income is regarded as a safe benchmark.
A repayment schedule informs you about your residual debt risk
A repayment plan is the basis of secure construction financing. At each point in time of the financing, it not only provides direct information on the monthly installments to be paid to the bank, but also shows the current status of the remaining debt at that point in time. The residual debt, in turn, is the most important value for the subsequent follow-up financing. Because it gives information about which amount must be further financed after conclusion of the Erstfinanzierung. In the case of an annuity loan, not only the monthly interest and repayment installments change over time, but also the residual debt amount.
You will receive the repayment schedule from the bank at the beginning of the financing process. They should request this already with the Erstangebot deer bank. But even before you get in touch with a bank, you can work through the options to minimize your residual debt risk. The higher you pay z. B. adjust the repayment rate, the faster you will be debt-free. And the longer the fixed-interest period, the more secure your financing. Use online repayment calculators to work out various repayment amounts and terms in advance. This not only shows the effect of a higher repayment on the interest costs and on the residual debt. In this way, you research your perfect balance between the fastest possible repayment and a financially reasonable monthly installment in advance. This applies to both initial and follow-up financing. To get this overview, we recommend the accedo repayment calculator (>link).
Bank-independent advice is important
For understandable reasons, banks are interested in keeping their own risk as low as possible when granting loans. That's why they prefer shorter terms and lower repayment rates. For your secure financing in a rising interest rate market, however, the exact opposite applies: longer interest-linked terms, high repayment and the lowest possible total term of financing. That's why we recommend contacting a bank-independent and reputable construction financing broker who can offer you secure financing tailored to your life plan. They also have daily access to the offers of more than 450 banks and can thus provide you with the bank as a lender that can make the best offer, both in terms of term, flexible contract modules and rapid debt freedom.
The residual debt risk mainly affects first-time financiers. However, there are ways and means that you should know in order to keep this risk as low as possible.