The amount of the loan for the house purchase is significantly influenced by two sizes: the equity and the available monthly budget. In addition, borrowers should pay particular attention to the interest rate, which can be fixed for around 5 to 20 years.
Home purchase loan: the most important things in brief
- A high equity ratio has a favorable effect on the conditions.
- The monthly budget influences the amount of the possible repayment rate.
- Short loan terms are often associated with lower interest rates.
- Long fixed interest rates usually result in higher interest rates, but create planning security.
How much equity do I need for the home purchase loan?
Credit institutions grant a home purchase loan to customers who meet certain conditions. A prerequisite is a minimum equity ratio that fluctuates between 10 and 30 percent. The value refers to the total cost of the property to be financed.
Example: The property including all ancillary purchase costs incurs acquisition costs of USD 300,000. If a bank demands a minimum equity ratio of 10 percent, borrowers must show 30,000 USD in equity. If the minimum quota is 30 percent, it is 90,000 USD.
In general, a quota of 20 to 30 percent is recommended for owner-occupied properties. From the banks’ perspective, a high equity ratio has a positive effect because it lowers the bank’s financing risk. If you bring in a lot of equity, you will take up less money. This means that the repayment is faster. Banks reward this aspect with a lower interest rate.
Note: Only a few consumers can take out a loan for buying a house without equity. Financiers only agree to full funding if applicants either have a very high monthly income or have large, tied assets that they do not want or cannot turn into liquid money in the short term. Home equity financing for the average earner is generally only approved using equity.
What is part of equity?
Equity differs in direct and indirect means. The direct equity funds are available immediately or can be made available within a short period of time.
- Current account credit
- Credit on call money account
- Federal bonds
- Stocks, equity funds and bond funds
- Allocation maturity building society contract
- Expiring capital life insurance
Indirect equity, also called equity replacement, is linked to an obligation that is financial in nature or requires your own work. The following list includes indirect equity and the associated conditions.
- State funds for housing promotion and Lite Lender funds require a repayment obligation.
- Life insurance policies are accepted as equity against assignment. The contract is still to be served.
- Employer loans and other loans from relatives and friends involve payment obligations.
- Personal contribution obliges to work on the construction.
The exposure rate: how much budget is available for repayment each month?
The second factor that determines the amount of the (maximum) credit is the monthly budget that is available. In general terms, it is the burden rate, which indicates the relationship between net income and credit burden.
Example: There is a monthly net household income of USD 2,500. The loan rate is 800 USD, which is 32 percent of the net household income.
To determine how much money is available for loan repayment, borrowers need to list their current income and expenses. The table below shows which positions such an overview contains using exemplary numbers:
If the borrower now compares the income of 2,500 USD with the expenditure of 1,500, there is a sum of 1,000 USD that could be used for a monthly loan installment. But for security reasons, borrowers shouldn’t stretch their entire budget to the last cent. This creates the risk that they will no longer have financial scope in the event of future unpredictable events. It makes sense to plan a financial buffer of around 10 to 20 percent for the unpredictable out of due diligence towards yourself and the family.
Three empirical values to determine the maximum amount of a loan
Financial institutions have a lot of experience when it comes to buying a house. However, private individuals only take out a loan for a house once in their life, rarely more often. Since they have no routine and no benchmarks to recognize how high a loan can be to be on a secure basis, they can use three relevant empirical values that banks use.
Ratio 30/30: Financings with an equity ratio of 30 percent and a debit ratio of 30 percent are on a very good basis.
Example: If the house including all additional costs costs 200,000 USD, equity capital of 60,000 USD is required. With an income of 2,500 USD net, the monthly rate should not exceed 750 USD.
Ratio 25/40: The house purchase is on a satisfactory basis if the equity ratio is 25 percent and the encumbrance rate is 40 percent.
Example: If the house including all additional costs costs 200,000 USD, equity capital of 50,000 USD is required. With an income of 2,500 USD net, the monthly rate should not exceed 1,000 USD.
Ratio 20/50: Financing the house is just acceptable if at least 20 percent equity capital is brought in with a maximum exposure rate of 50 percent.
Example: If the house including all additional costs costs 200,000 USD, equity capital of 40,000 USD is required. With an income of 2,500 USD net, the monthly rate should not exceed 1,250 USD.
Interest comparison: effective interest as a key figure
How effective a loan really is can be seen from the effective interest rate. This value includes all costs and aspects that the borrowing causes. These include, for example, the borrowing rate, costs for residual debt insurance, commitment interest, valuation and processing fees. Clause 4 of the Price Disclosure Regulation (PangV) obliges banks to use the effective interest rate to show the actual costs, i.e. the total price of the loan. The value enables consumers to compare offers from different providers.
Loan calculator: finance the house and find the best option
If you plan to take out a loan to buy a house, you should compare several financing options. It is worth playing with the values and using a financing calculator. Because a house can be financed in different ways, and changing the individual calculation parameters ensures different results. For example, the changes might look like this:
- If the borrowing rate increases, the interest rate rises and with it the monthly charge.
- If the repayment rate is set higher, the interest rate drops and the monthly charge increases.
- A special repayment shortens the term and may have no effect on the interest rate. Several special repayments can have a negative impact on the interest rate.
What factors affect interest rates?
The level of the interest rate is influenced by various aspects. Depending on the provider, numerous factors play a different role. In general, however, a distinction can be made between personal and financial factors.
Note: In addition, there is the general capital market situation. It is the starting point that determines the general interest level. Since 2016, interest rates on real estate loans have been at historically low levels. They are based on the yields for long-term bonds and Pfandbriefe as well as the key Binary Lender interest rate and are on average a good half percent higher. Based on this market-dependent general building rate, personal and financial factors of the applicant influence the interest rate on the building loan.
- Occupation/employment relationship and status: civil servants, white-collar workers, auxiliary workers, self-employed, pensioners, students, etc. Civil servants receive much better conditions in comparison. The more stable the professional situation, the lower the interest rate.
- Place of residence: Some banks only finance in a certain region and take risk premiums if they finance outside of the region.
- Planned real estate use: Real estate that you use yourself benefit from special promotional loans that can represent equity replacement. Rented apartments must have certain lending value requirements. These factors affect the level of the interest rate in both directions.
- Creditworthiness: Banks assess the entire wealth and income situation to determine the creditworthiness. Income and current loans that are already running play a role here. An excellent credit rating results in a good interest rate, less good credit rating means a lower interest rate.
- Amount of the loan: Some banks have requirements regarding the minimum and maximum amount. High loans are sometimes offered on better terms.
- Equity ratio: Every USD has a positive effect. The more equity is brought in, the cheaper the interest rate.
- Fixed interest period: Long fixed interest periods cause the interest rate to rise. But they also ensure planning security because the interest rate is fixed longer.
- Redemption component: the higher the agreed redemption, the better the interest rate. However, the monthly charge also increases.
- Special agreements: Repayment rate changes up to two times during the term and special repayments are standard. Anyone who wants to make further special agreements must expect surcharges.