What is an equity loan and how does it work? “Credit for equity capital” – that initially seems to be a contradiction. If the intention is to build or buy a house, however, loan financing in connection with the required equity capital can certainly make sense. It depends on the particular constellation. Who actually writes and advises here? About us On this page What does equity mean? Equity and home finance What does “credit for equity” mean? Are promotional loans equity capital? Child benefit as “real” equity Compare loans directly
When do you speak of equity?
Equity is own property that belongs to the owner or home buyer, without third party access rights or claims. It is fully owned. A distinction is made between financial assets and tangible assets. Tangible assets primarily consist of tangible objects – for example real estate, facilities, long-term consumer goods. In addition to cash holdings, financial assets primarily include capital and cash investments (bank deposits, securities, life insurance).
Financial assets are comparatively easy to liquidate and can therefore be used well for financing purposes, depending on the type of capital investment. On the other hand, this is more difficult in the case of property, plant and equipment, since it is not uncommon for long-term capital tied up. This may make it necessary – at least temporarily – to look for alternative financing, even though there are assets: just a “loan for equity”.
How important is equity for home finance?
Banks generally expect a certain share of equity in mortgage lending. There are also so-called hundred percent financing. To do this, you have to have a first-class credit rating, and such loans are more expensive than “normal” home loans. From the lender’s point of view, the contribution of one’s own assets to the financing reduces the risk. Interest is not payable for equity capital, and there is no repayment obligation. This makes it easier to service loans. Payment disruptions or defaults are less likely.
How much equity for mortgage lending?
An equity share of 20 percent is a rule of thumb for real estate financing – at least for owner-occupied housing. In the case of rental properties, the calculation is somewhat different in some cases. How much equity you have to show also depends on the bank and the individual credit rating. The equity component also plays a role in loan terms. The lower the risk, the cheaper the financing.
What does “credit for equity” mean?
“Credit for equity” can have the following meanings in connection with a real estate loan:
- A loan should be taken out because one does not want to use existing equity for the financing.
- (Temporary) financing is required because existing equity capital is not available as quickly or only at a disadvantage.
- Financing is necessary because there is no equity and only has to be formed over time.
The building society contract: classic combination of credit and equity
The classic combination of self-financing and debt financing for real estate is the building society savings contract. However, equity is initially created, then the loan follows – not the other way around. In the savings phase, regular savings are used to systematically save a home savings credit. If the contract is ready for allocation, the credit can be paid out and an additional home loan can also be drawn. Both can then be used for financing. The conditions are fixed from the start. This makes building society contracts very predictable. The opposite way – first loans, then equity capital – is the connection of a final loan with a home loan contract. More on this in the next section.
Final loans: first credit – then equity
As a rule, real estate financing is annuity loans. That means: The loan is repaid in regular, constant installments with an interest and repayment component. It is different with so-called final loans – also called repayment loans. Here only interest payments are incurred during the term of the loan. The repayment is made in one sum at the end of the term. Instead of the current repayment, a repayment replacement is gladly agreed for such loans. During the term, (equity) capital is systematically saved, which will ultimately be used for repayment.
In this sense, the repayment loan can be seen as “pre-financing” for (not yet) available equity capital, which is only formed during the loan term. There are different ways of capital formation. Building savings contracts or endowment policies are common – since they are easy to calculate. Fund savings plans, fund-based life insurance plans or bank savings plans are also conceivable. In the case of owner-occupied real estate, final loans usually do not pay off, but things can be different with rental properties because the loan interest is tax-deductible.
Interim financing – bridging until equity is available
The interim financing is usually also a final loan. On the one hand, the difference to the repayment loan is the term: interim financing rarely lasts longer than 24 months. On the other hand, the repayment replacement is waived here. Because the equity capital for which the loan is taken out already exists, but is not yet available.
Typical constellations in which interim financing is considered are:
- Another own property is to be used to finance the real estate project, but has yet to be sold.
- There is a home loan savings contract that is not yet ready for allocation.
- An existing life insurance policy has not yet reached the end of its term.
- Investments are limited to certain periods and are not available early (e.g. time deposits, savings bonds).
- Existing investments could only be liquidated with considerable losses (due to price and stock market developments).
Interim financing is usually more expensive than “normal” mortgage loans because of the increased and additional processing costs. A variable interest rate “in line with the market interest rate development” is common. Loan existing equity? In theory, assets other than the property to be financed can also be used as collateral for long-term loans if they are valuable. You then get “credit for equity”. Borrowing only makes economic sense if the return on equity is higher than the loan interest. This is rarely the case. Otherwise, it is more advantageous to use equity for financing.
Are promotional loans “credit for equity capital?”
There are various support programs for builders and home buyers that support the financing. At the federal level, the Kreditanstalt für Wiederaufbau (Lite Lender) is responsible. The programs carried out by Lite Lender mainly work via subsidized loans. This applies to the programs:
- Energy efficient building
- Lite Lender Home Ownership Program
- Renewable energy standard
Lite Lender also offers additional grant-based funding for fuel cell heating and construction support, which can be combined with other programs if necessary. With the loan program “Energy Efficient Building”, a repayment subsidy is possible, which reduces the effective loan amount and how equity works. The promotional loans themselves do not represent equity capital, but they do support equity capital formation through interest rate reductions and in conjunction with grants.
Child benefit – ‘real’ equity Families with children who buy or build a house between January 1, 2018 and December 31, 2020 can claim child benefit as a subsidy, provided that the taxable annual household income does not exceed $ 90,000 plus $ 15,000 per child. Each child is paid 1,200 USD per year for 10 years – a total of 12,000 USD. Since these are grants that do not have to be repaid, child benefit is “real” equity. The application is made directly to the Lite Lender.
This article shows: there are quite a few different ways to get “credit for equity”. However, the best is usually a constellation in which sufficient equity is available when the financing of a property is due. In this way, additional financing costs can be avoided. A solid, long-term financial planning and a well-considered investment strategy can help to create an adequate equity base “at the right amount” and “at the right time”.