More than 90 percent of all property buyers in Germany need construction finance to realize the desire for their own four walls. Usually, there is some equity capital, so that the entire purchase price plus incidental purchase costs do not have to be covered by outside capital. However, many borrowers do not know the importance of equity in home financing and why there are several advantages when comparing it to full financing. Experienced real estate agents, such as Paul and Partner as agents from Wiesbaden, also point out the great importance of equity in real estate financing.
What is equity?
Equity is all the financial resources that the borrower has and that does not come from outside sources. He must also be able to bring this capital into the financing, because only then will it be eligible capital. A basic requirement is, therefore, the immediate liquidity and that the equity can be integrated into the home financing. Usually, the following assets and assets can be accepted as equity in mortgage lending:
- Balances in bank accounts, for example in a call money account
- Securities portfolio in the custody account
- Liquidate claims, for example from a life insurance policy
- Liquid assets, such as gold coins
In addition to these capital values and assets, so-called own contributions can also be accepted as equity by the bank when building a property. In turn, the client’s own work is deemed to be an activity that leads to less external costs. A typical example would be if you lay the tiles in your new house yourself, so that you do not need any craftsmen for this part of the work and thus save costs. However, most lenders only add their own contributions to equity to a certain percentage or maximum.
Why do banks ask for equity at all?
It has always been advantageous in the context of mortgage lending if the borrower had equity. The banks’ demand for own funds increased at the latest after the EU housing credit directive came into force in 2015. To a certain extent, this stipulates that banks place more value on the customer’s personal creditworthiness. This includes, among other things, a certain equity ratio, which can be used to support the fact that the financing is likely to be stable. The banks do not act arbitrarily but must adhere to EU requirements.
What is full funding?
The term “full financing” is often used in connection with equity. This is simply real estate financing with no equity capital. For this reason, the borrower must finance all costs, in particular, of course, the purchase price of the property or alternatively construction costs as well as purchase or ancillary construction costs. So, for example, if you buy a house in Wiesbaden and have no equity, you have to fully finance all costs through the bank loan.
Due to the fact alone, full financing is always more expensive than home equity financing because a higher loan amount is required. The extent to which full financing can lead to higher interest costs compared to home equity financing is shown in our following example.
Full financing vs. Home equity financing with equity: a sample comparison calculation
Below we show you two calculations. On the one hand, the borrower has equity of 20 percent and can include this in the mortgage lending. On the other hand, there are no own funds, so full financing must take place. As you will see shortly, equity capital saves you considerable interest costs in some cases.
•€ 275,000 Ancillary purchase costs: € 35,000 Equity
•€ 62,000 Real estate loan
•€ 248,000 Initial repayment
•3.5% Interest rate
•0.95% Interest costs in the first year
•2,356 euros Monthly credit installment
•€ 275,000 Ancillary purchase costs
•€ 35,000 Equity
•0 € Real estate loan
•€ 310,000 Initial repayment
•3.5% Interest rate
•1.65% Interest costs in the first year
•5,115 euros Monthly credit installment
In this example, the interest savings in the first year would be around EUR 2,750 if you compare the home financing with equity to the full financing. If we include the redemption settlement, you would thus be able to save around 24,000 euros in interest costs in the first ten years of mortgage lending. For this very reason, experienced brokers such as Paul & Partner, as real estate agents from Wiesbaden, advise you to include as much (as much) equity as possible.
The savings result on the one hand from the lower loan amount, but on the other hand also due to the lower interest rate that banks offer with home equity financing compared to full financing. As a positive side effect, the monthly loan rate with equity is of course lower, since a lower loan amount is required. In the example, as a borrower, you, therefore, have to pay a monthly loan rate of more than 400 euros if you bring 20 percent equity into the financing.
Loan approval is more likely with equity
There is another advantage that borrowers can benefit from, for example, if they buy a condominium in Wiesbaden and then incorporate equity into their home financing. This advantage is significant because it can possibly lead to you being able to take out a real estate loan at all. For banks, equity means more security and therefore a lower risk of default than with full financing. Therefore, with equity, it is more likely that the application for a real estate loan will be approved than if it were to be fully financed. So equity simply increases your chance of making a positive loan decision.
The advantages of equity in home finance in comparison
At this point, we would like to summarize the advantages that equity in home finance can have for you as a borrower. You benefit from your own funds in the following way, especially when compared directly with full financing:
- The bank’s loan approval is more likely with equity
- Funding stability is increased
- Banks offer cheaper loan interest
- Save interest costs
- Lower monthly loan rate
What is the required equity ratio?
The equity ratio is the proportion of equity that you can include in real estate financing in relation to the total costs. If the upcoming house purchase, for example, caused 250,000 euros + 50,000 euros in additional costs and you had 60,000 euros in equity, the equity ratio would amount to 20 percent. This ratio will suffice for most banks, even if, of course, each lender individually determines what minimum equity ratio he would like to have. Usually, however, an equity share of between 15 and 25 percent is sufficient as a minimum.
Some banks still offer full financing today. However, this is not recommended for the reasons mentioned. Therefore, you should definitely include own funds in-home financing if you are able to do so. The full financing is not only (significantly) more expensive, you also have a higher monthly charge, and, last but not least, cancellation of your loan application is more likely than with equity. If you want to buy a house in Wiesbaden and have questions about equity within the scope of financing, experienced brokers such as Paul and partners will be happy to answer you.