Real estate financing: How much equity do buyers need?

Full financing: risk for banks and customers

For most people, owning their own property is the biggest investment in life. It is therefore all the more important that this is solidly planned, secure in the long term and permanently affordable. Since hardly anyone has enough savings to buy a property “in cash,” according to a Bundesbank survey in 2019, loans amount to around 70 percent out of all lending to domestic companies and private individuals. In 2021, a real estate portal determined that after all 85 percent of buyers contribute equity.

Full financing is therefore rare in Germany. As a rule, not just 100 percent, but up to 115 percent must be made available — to cover additional costs such as real estate transfer tax, broker and notary. Banks in this country are also cautious when it comes to full financing. And for good reason: Both the bank itself and the real estate buyer bear high risks when financing the full purchase amount without reserves.

• Risk factors for banks

If a borrower is no longer able to service his installments, the property is usually sold quickly and for a lower price than the remaining debt is at the time of sale. If the borrower no longer owns real estate as a result of a forced sale, he still has to pay his remaining debt with the bank, which often leads to payment defaults.

• Risk factors for borrowers

But even if the borrower services the installments, follow-up financing can be very expensive if interest rates rise. Due to the largely high residual debt and lack of reserves, favourable interest rates are barely negotiable with the bank — in the worst case scenario, the borrower can no longer afford the increased interest costs and there is a risk of foreclosure. Due to the high risks, full financiers often have to reckon with poorer loan terms.

How much equity do property buyers need?

In general, the more equity a builder or real estate buyer has, the fewer risks he takes on. Equity also opens up more room for negotiation with the bank and, in the end, often lower loan interest rates.

Customers are currently still benefiting from very low construction interest rates. But anyone who wants to become a property owner today must be prepared for a long search and high prices due to the tight market situation in sought-after areas. In certain regions, real estate prices have risen by 60 percent or more since 2010 — with a relatively consistently tight supply and high demand (due to low interest rates).

On average, buyers in Germany spent around 263.00 euros on their property in 2019. There are also additional purchase costs, which — depending on the federal state — amount to between nine and almost 13 percent of the purchase price. In the case of an apartment for 300,000 euros, the purchase of real estate under all other conditions requires around 9,000 euros more equity.

Most lenders recommend financing at least 20 to 30 percent of the total costs of buying real estate out of their own pocket. Equity includes cash and savings, shares and securities, a private plot of land, an inheritance or gift.

The advantages of a high equity ratio are obvious: Borrowers can negotiate lower interest rates and thus repay the loan amount more quickly. Financing opportunities are also increasing, as the bank does not have to take on too much risk.

What options are there for raising equity?

But especially at a young age, many still do not have enough equity to finance a property. According to an iwd study, 25 to 34-year-olds own an average of 21,570 euros, 35 to 44 year olds 61,340 euros, 45 to 54 year olds 110,200 euros and 55 to 64 year olds 124,900 euros. So if you want to buy your own home early on, you should either have inherited assets or ideally start saving at a young age. Because the longer the investment horizon, the more savers benefit from the compound interest effect.

ETFs or (savings plan-linked) equity funds are a popular way to save money. Due to the broadest possible diversification into different stocks and regions, the risk is lower than with individual stocks. However, investors should have an investment horizon of at least ten to 15 years. This is the only way to compensate for weak market phases and setbacks over time and limit the risks of loss.

Although building loan and loan contracts are very popular in Germany, they are a very complex investment product that has several disadvantages. The basic idea: With a building loan agreement, you save equity and then receive a cheap loan for part of the real estate financing. First, the customer must save part of the building savings sum — usually 30 to 50 percent. During the savings phase, interest is paid on the assets. However, interest rates for building savings are currently so low that even a call money account often offers better conditions.

After a certain period of time, the contract is “ready for allocation”. This means that the saver can call up the loan for the construction loan. As soon as the allocation has been made — which may take months — the customer receives the missing amount as a loan. Its repayment rate consists of the repayment and the interest rate set when the contract was concluded.

Should capital market interest rates be higher than the agreed interest at the start of repayment, the building saver enjoys an advantage. However, if interest rates remain the same or even fall, the customer pays more than with a “normal” real estate loan.

The high costs are also disadvantageous: A building loan and loan contract requires a so-called closing fee. The closing fee depends on the amount of the building savings sum. Depending on the building society, the closing fee is between 1% and 1.6% of the building savings sum. Even ongoing, often opaque, fees can ultimately drive up costs.

Save for your own home with digital real estate shares

An innovative way to build up wealth in the long term is tokenized real estate investments. Investors can thus both benefit from promising return opportunities on the real estate market and save capital for their own home. During tokenization, the provider splits an object into small shares — so-called tokens. These tokens digitally represent the property on the blockchain. Investors can buy tokens and thus an owner can benefit from the property for as little as 500 euros. This gives them the right to profit from the property through rental income or increase in value and remain flexible: Real estate investors can use their tokenized shares at any time on the secondary market offer for sale.