Full real estate financing: “the risk is considerable”

Buying a house on credit "The risk involved in full financing is considerable"

Tobias Just is a professor of real estate economics at the University of Regensburg. Source: PR

Tobias Just is a professor of real estate economics at the University of Regensburg.

A house purchase without own capital funds carries large risks, stresses real estate economist Tobias Just. In an interview, he explains what prospective home builders should bear in mind.

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Tobias Just is a professor of real estate economics at the University of Regensburg and keeps a close eye on developments in the real estate market. In an interview, he explains the consequences of the situation on the market, especially for young prospective buyers, and why financing without equity is not a good option for most people.

WirtschaftsWoche: Lack of equity is often the sticking point in real estate financing. But on average, 25 to 35 year olds have just over 20.000 euros saved up. How are young people supposed to make their way into home ownership in the first place??
Tobias Just: I don’t think it makes sense to move into your own home right after graduation at the end of your 20s and possibly with university debts. It is definitely advisable to build up savings for a few years first. That’s a form of self-discipline – and it’s something you have to practice. Buyers must not forget that a higher equity ratio ultimately means more leeway when it comes to repayments.

There are, of course, many advantages to private home ownership: real estate has a higher return than savings accounts or government bonds because of the risks involved, buyers are forced to save because of the repayment obligation and, ultimately, buyers can positively influence their own return by making their own contributions.

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Home buyers should have an equity ratio of 30 percent on the high side, warn real estate experts and consumer advocates. Is that reasonable?
Currently I consider such a rate for young families relatively high. The interest rate situation currently allows you to take out higher financing. No one expects interest rates to rise in the next few years. The follow-up financing after the end of the debit interest commitment is today quite comfortable. The own capital buffer loses so somewhat in meaning.

Nevertheless: It is meaningful to bring in own capital, in order to be able to receive better conditions with the bank. It should also not be overlooked that a combination of rising real estate prices and high transaction costs have made access to real estate purchase more difficult. Traditionally these purchase additional expenses and a first tranche of the purchase price are brought in as own capital funds. That exceeds however with the allermeisten young people fast the possibilities.

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That’s why we should strive to reduce ancillary purchase costs. In Germany, the real estate transfer tax ranges from 3.5 percent in Bavaria or Saxony to 6.5 percent in Saarland or Brandenburg. With an apartment for 300.000 euros requires the real estate purchase under otherwise same conditions alone 9000 more own capital funds.

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The purchase additional expenses make – depending upon Land – between nine and nearly 13 per cent of the purchase price. Would a reduction bring real estate prospects at all so far forward?
At least a little. Currently, the average age of first-time homebuyers is over 40 years old. If the ancillary purchase costs were halved, the purchase could take place a few years earlier.

Most banks offer full financing. They advertise that they can make the dream of owning a home come true even without a cent of equity. Doesn’t that sound too good to be true??
For a large part of the young prospective buyers the full financing is the only option to come to own home without waiting period. If I were an investment advisor, however, I would only recommend full financing to a very small minority of people. The catch is: if you can’t bring in any equity capital, you are dependent on the bank. As soon as the conditions change – be it interest rates or other repayment modalities – this makes repayment more difficult.

In the case of emergency one is closer to the Zwangsversteigerung. In addition, full financing does not solve the problem of repayment. The redemption period would stretch over a longer period or would have to be repaid in larger tranches, because without equity capital the effective annual interest rate increases rapidly to double compared to an equity capital contribution of 30 percent.

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So buying a house without equity is not without risks.
Especially at the age when many are aiming for full financing, life situations can change dramatically: Changing jobs is just one example. If, in the worst case, the property has still lost value, those affected must continue to pay off the debts even after selling it. The risk of full financing is considerable.

Thousands and thousands of jobs are at stake in the corona crisis. With it also the financial basic structure wobbles with many real estate owners. Are we moving towards a German subprime crisis in view of the large number of fully financed properties??
I do not believe that. In Germany, financing is much more conservative than it was in the USA before the real estate bubble burst. Repayment and equity ratios in this country tend to be high. Of course, problems can arise at the edges: In the wake of this sharp recession, it would be likely that the number of foreclosures would increase – but from a very low level. But area-wide price erosion is not to be expected, as demand remains high and there is no significant vacancy rate. Unlike in the U.S. at the time, where many fully financed properties were empty.

Interest rates have been at record lows for years. But no one can give a reliable answer as to how the level will develop in 30 years’ time. What home buyers need to consider?
Buyers should tend to aim for the longest possible fixed-interest period. An increase in interest rates – as unrealistic as the capital markets currently consider this to be – would otherwise become a Herculean task for many people. Planning security pays off.

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