Construction financing: types of loans

Various types of loans are used in real estate financing, in particular the annuity loan

In the context of a mortgage, most banks provide not only one type of loan, but several credit cards. Therefore, it is important for you as a customer and prospective borrower to know at least the basic characteristics of the different loan types. Therefore, in the following we would like to take a closer look at the types of loans that in some or many cases are part of a real estate financing transaction.

Single-family house with carport © schulzfoto,

The different loan types at a glance

First of all, we would like to give you a brief overview of the types of loans that are usually used within real estate financing. It is not uncommon for construction financing to even consist of a mix of several types of loans. Not every type of loan mentioned below is provided by all banks. Usually, however, you can choose at least between two to three different variants of the real estate loan at most credit institutions.

In addition, there are other lenders outside the banking sector, whose loan can also be integrated into the financing. In summary, the following types of loans exist that can be integrated into construction financing:

  • Annuity loan
  • Repayment loan
  • Full repayment loan
  • Term loan
  • Building loan
  • Foreign currency loan

Annuity loan: the most frequently used real estate loan

By default, almost all German banks active in real estate financing offer at least the so-called annuity loan. Annuity is another name for annual installment, but still you pay the loan installments monthly even with this real estate loan. A characteristic of the annuity loan determines that the monthly loan installment is composed of the repayment on the one hand and the interest on the other hand. Thus the annuity loan has at the same time a commonality with the repayment loan and also the building society loans.

A difference between amortization loans and annuity loans, however, is that with the annuity loan the share of interest and repayment in the total installment keeps changing. If the initial repayment is three percent, for example, this increases over the course of the repayment period. In contrast, the interest portion of the loan installment is reduced. This is due to the repayment offset.

Since you regularly repay your real estate loan within the monthly installment in the form of the annuity loan, a lower residual debt exists after this repayment settlement. The interest is always calculated only on the remaining debt. Therefore, the interest portion of the monthly installment decreases continuously. With the annuity loan thus the portion of the repayment shifts in the course of the years and becomes ever larger. The rate as such, however, remains identical throughout the duration of the agreed fixed interest period. Therefore, the annuity loan is equipped with a high calculation security.

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Repayment loan: Common alternative to the annuity loan

If you do not choose an annuity loan as part of your construction financing, you may choose the amortizing loan. With this real estate loan, too, the monthly installment consists of repayment on the one hand and interest on the other. The difference between this and an annuity loan, however, is that although repayments are also offset, the share of repayments in the total instalment does not increase. What this means?

The repayment always takes the same share in the amortizing loan, for example, four percent per year. With this percentage, you know that the total debt will be repaid after exactly 25 years. Since the repayment portion does not increase despite repayment offsetting, but the interest portion decreases, it is typical of the amortizing loan that the monthly loan installment continues to decrease over the repayment period. That is why the amortizing loan is popular, among others, with borrowers who can already foresee that the complete redemption of the loan will reach retirement age.

In this case, the borrower benefits from a significantly lower loan installment in the meantime and thus has a lower monthly burden. The amortizing loan – similar to the annuity loan – also has a high degree of calculation security. As a borrower, you know exactly how many years it will take to repay your loan debt in full and have a high degree of interest rate security with a fixed interest rate for the corresponding period.

Credit agreement © Dan Race,

Full repayment loans: Popular in the low-interest phase

The full repayment loan is due to the low-interest phase in particular in the last years with ever more borrowers in the course of the building financing the first choice. The reason is that in the full amortization loan the total term of the real estate loan and the period of fixed interest rate are identical. With the usual real estate loan, for example, in the form of an annuity loan, the duration of the fixed interest rate is almost always less than the total term of the loan. This means that you may have paid off your real estate loan in full after 25 years, but the fixed interest rate is only for ten years.

With the full repayment loan, there is no difference between the total term of the real estate loan and the fixed interest rate period. In the example, this would mean that you will have fully repaid the real estate loan after 25 years, but the fixed interest rate also applies for 25 years. Thus, the full redemption loan includes an enormous interest rate security. There is no interest rate risk, as there is no need for follow-up financing at a later date. With the usual repayment loan or with the annuity loan however this interest rate change risk exists after expiration of the interest fixed period. In this case, the interest rate may already have risen significantly as part of the follow-up financing.

Tip: The full amortization loan is highly recommended in the current interest rate situation. You secure the currently extremely low construction interest rates for a very long period of time, namely until the complete repayment of your real estate loan.

Term loan: Complete repayment at the end of the term

One form of real estate loan that is rarely used today, mainly due to the low-interest phase, is the so-called bullet loan. Characteristic is that the monthly loan installment to be paid does not consist of interest and repayment, but the borrower pays within the rate only the agreed interest. So what happens with the – of course also necessary – repayment of the bullet loan?

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