What is the so-called repayment? Finding a definition for the term "repayment" is actually quite easy. Ultimately, repayment is nothing more than paying off a loan – a debt is repaid by paying back a sum of money. This also applies to a forward loan.
But the cost of a loan isn't just the ongoing repayments. To calculate the total cost of a loan, you need to add up the monthly interest and the monthly repayment rate. The overall result is then referred to as debt service.
Repayment plays an important role, especially in construction financing
In the case of a small loan, the question of repayment is easy to answer. You agree on a duration for the repayment of the consumer credit. Depending on the agreed duration of the loan agreement, the amount of the monthly repayment is automatically determined. The bank will give you a rate, which is the initial repayment and the initial interest, and ideally this will be paid until the end of the loan term. In the end, the installment loan is paid off.
The situation is different in the case of construction financing. Here, the amount of repayment is freely negotiated between the lender and the borrower in the beginning. Here, too, the repayment naturally has a considerable influence on the term of the total repayment. However, only in the rarest of cases is a construction loan completely repaid by the end of the fixed-interest period. Much more, at this time a new financing must be agreed to pay off the remaining amount still to be repaid.
Particularly in the case of construction financing, it is important that you keep a close eye on the interplay between repayment and interest when selecting the repayment rate. In the case of a simple consumer loan, the interest rates are lower the shorter the loan term is agreed. At the same time, many banks and credit institutions reduce their interest demand for a construction loan if you make a correspondingly high repayment offer.
The higher the repayment agreed between you and the bank, the faster you will have repaid the loan. A shorter repayment term, in turn, means a significantly reduced overall interest burden and thus, on balance, significantly lower overall borrowing costs. Experts recommend that, if possible, a repayment of around 3 percentage points be agreed upon when the interest rate is 1.x percent.
Three common ways to structure repayment
When it comes to the question of how you want to structure your repayment as part of a construction loan, there are several possibilities. The following three are the most common – although experts often advise against option number three.
- Repayment in the context of a classic annuity loan
- Repayment in the annuity loan with the possibility of unscheduled repayment
- Loan with bullet repayment
In the following, we have defined the differences between the various options and their advantages and disadvantages.
Classic annuity loan
In the case of a classic annuity loan, you agree on an interest rate and a repayment amount when concluding the loan agreement. The respective percentages are used to calculate the total amount you must pay to your lender each month.
In principle, the initial repayment is only paid once in the first month. This is because the interest payments in an annuity loan behave dynamically. Month after month, the interest is converted to the remaining loan amount after the last repayment. Let's assume a loan installment of 500.00 euros, where you pay in the first month interest of 250.00 euros and a repayment of also 250.00 euros. Here the weight shifts every month more in the direction of repayment. In the first months it is only a few cents.
Gradually, the difference becomes greater and greater, so that at some point you pay 300 euros in repayment and only 200 euros in interest. In this way, your residual debt will continue to decrease as the repayment period progresses. The originally agreed upon percentage of repayments is sometimes significantly exceeded after only a few years. For this reason, the originally agreed amount is referred to as the initial repayment.
Annuity loan with the possibility of unscheduled repayment
The annuity loan with the possibility of unscheduled repayment is structured in the same way as the classic annuity loan. The only difference is that here you have the possibility to make repayments out of turn. This allows you to further reduce the remaining interest payments and thus significantly increase the total repayment over the duration of the fixed-interest period.
Final repayment
Unlike an annuity loan, you do not make any repayments to the lender here. Much more, with a loan with bullet repayment, you only pay the monthly interest. Only at the end of the credit period, the repayment is due in one sum.
This option was often used in the past, for example, when people who were ten years away from paying off a large endowment life insurance policy wanted to use it to pay off their construction financing, for example. If the life insurance was sufficient of the total amount, the payout was secured at the end as a bullet repayment and the borrower only paid the interest over the years. As a result, the monthly costs are of course significantly lower. However, this does not reduce the amount of monthly interest either.
Today, this variant is sometimes offered in combination with building savings contracts. In these cases, you pay the monthly interest to the bank and the monthly installments into the building savings contract quasi as repayment, which, however, is only due when the building savings contract is ready for allocation. Those who are entitled to allowances under a building subsidy can actually benefit financially here. However, the total allowances for this must be high enough.
Advantages and disadvantages of the individual variants at a glance
| Repayment method | Advantages | Disadvantages |
| Annuity loan | – The monthly repayment reduces the interest burden each month |
– With an initial repayment of 3 percent, considerably more than 30 percent of the loan will have been repaid after 10 years
– Through additional special payments, the duration of the repayment can be further reduced
When things don't look so rosy financially
You have a financial bottleneck for a foreseeable period due to an unforeseen event? In this case, most lenders are willing to talk, so that a repayment break can be agreed upon. Then often only the interest payments are due, so that you have a little more liquid funds available for a few months.
Some lenders even offer a complete installment break – in this case, however, the full installments are also added at the end of repayment.
Example situations in which a suspension of repayment or a break in installments may be an option
- Not self-inflicted unemployment
- Serious illness and therefore the temporary receipt of sick pay
- Short-time work
- Restrictions on your ability to practice your profession due to pandemic response measures
How can a repayment be deducted for tax purposes??
The repayment of a construction loan can only be tax deductible if you can deduct part of the house or apartment as a workroom. However, the deduction options here are severely limited. For example, you must prove that you have no other job available where you could pursue your activity.
If the property is a mixed-use property, for example because your store or workshop is also located in the house, the repayment for the part of the house used for business purposes can be claimed against tax.
Conclusion: choosing the right repayment method can significantly reduce your loan costs
Depending on the type of repayment and the amount of the initial repayment, you will be finished with the repayment of your building loan sooner or later. It is clear, of course, that the shortest possible loan term also leads to lower overall borrowing costs. However, you should always remember to choose the rate of interest and repayment so that you still have reserves and a buffer available for emergencies.