A subordinated loan is often associated with worse interest rates. This article explains why this is the case and how you can counteract it.
- The most important facts about subordinated financing at a glance
- What is subordinated financing?
- What is meant by "subordination" in a subordinated loan??
- What is the difference between senior financing and subordinated financing??
- What interest rate conditions can I expect with subordinated financing??
- What does subordinated financing mean in practice?
- What role does the loan-to-value play in a subordinated loan?
- What are the special features of subordinated financing??
- How can I avoid subordinate financing??
The most important facts about subordinated financing at a glance
Below you will find a summary of the most important information about subordinated loans:
- A subordinated loan is a loan whose land charge is recorded in the land register after the 1. Rank is registered. This is also referred to as "subordinated".
- The term "subordinated loan" is commonly used as a synonym.
- If a foreclosure sale occurs, the proceeds are paid first to the creditor of the first-ranking land charge. If anything remains, the creditor of the second-ranking land charge is paid out, and so on.
- A subordinate financing is often accompanied by worse interest rate conditions.
- Building societies or KfW usually include a subordinated loan in their calculations. The interest conditions are then better than with an annuity loan.
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What is a subordinated financing?
Subordinated financing is the term used to describe a loan whose land charge is not entered as a first-ranking lien in the land register, but as a second-ranking lien in the mortgage register. or 3. Rank, that is, subordinate. The term "subordinated loan" is often used as a synonym in practice. You will usually get a worse interest rate for a subordinated loan than for a first lien loan.
With our construction interest calculator you determine your individual rate. Taking into account the data you have entered, you will receive the daily updated interest rate.
What is meant by "subordination" in a subordinated loan?
A real estate loan is secured by the bank registering a land charge in the land register. If the borrower can no longer afford his monthly installment, the bank can schedule a foreclosure sale in order to be able to pay the outstanding installments from the proceeds. With the land charge registration, the bank receives a so-called "right in rem" to exploit the property.
If this scenario occurs, the bank that has a first-ranking mortgage registered in the land register receives its money first. If there is still money left over, the subordinated lenders will also receive your outstanding receivables.
How senior financing differs from subordinated financing?
For your first construction financing, the bank is entered in the land register as the first-ranking creditor. Our land register calculator shows you the resulting costs. Suppose you now want to take out another construction loan while the first one is still in place. For example, because you still want to finance an extension. Then the bank that grants you the second construction loan is entered in the land register with subordinate status behind your first bank. This is why we also speak of a subordinated loan or subordinated financing.
The second bank then also receives security for the money lent through the land register entry. If you subsequently become insolvent, this means: First the first bank may put its right in rem into practice, and then the second bank. Because it is not possible to say for sure whether there will be anything left for the second bank after the foreclosure sale, for example, subordinated financing is associated with a higher risk for them. For this reason, subordinate loans are generally more expensive than senior financing. Through higher interest rates, the second bank offsets its risk again.
What interest rate conditions can I expect with subordinated financing??
In most cases, subordinated financing is associated with higher construction interest rates. This means that the interest rates on a subordinated loan are significantly lower than the interest rates on a senior loan. The differences here are between 0.3 and 0.9 percentage points.
If you can offer the bank an equivalent security, which is not preloaded, it waives under circumstances an interest increase.
Some credit institutions are already prepared for the increased risk that results from subordinated financing. A KfW subsidy or offers from building societies are not necessarily associated with worse interest rates.
What does subordinated financing mean in practice??
What a subordinated financing means in practice, we show with an example.
Let's assume there are 2 loans. One loan is entered in the land register with a first-ranking land charge, the other loan is entered with a second, subordinate land charge:
- First-ranking land charge: 50.000 €
- Subordinated land charge: 80.000 €
The borrower can no longer meet the claims. A foreclosure occurs. The proceeds from the foreclosure sale are 100.000 €. This results in the following breakdown:
- The loan with the first-ranking land charge can be repaid in full with the proceeds.
- The loan with the subordinate land charge can only be financed with 50.000 € can be repaid.
This means that the bank, whose land charge is subordinated in the land register, remains at a cost of 30.000 € are sitting.
What role does the loan-to-value ratio play in a subordinated loan??
With the lending value, the bank determines the sum that it would lend to the borrower. As a rule, the bank does not finance the entire purchase price of a property. The mortgage lending value is the amount a bank is likely to receive in the event of an auction. Usually the bank calculates with 70 to 90 % of the purchase price. The lending limit, i.e. the maximum amount that a bank is prepared to pay, is 60% of the mortgage lending value. The table illustrates the numbers: