Final loan – advantages and disadvantages using the example
Anyone who decides on a final loan only pays the interest due until the end of its term, the actual amount, on the other hand, is only paid in full on the agreed due date. To ensure that the borrower is able to make the repayment at maturity, the banks have the availability of the total amount secured with capital investments. In addition, the credit institutions require an interest premium on the loan, since this itself represents a much higher risk than other types of loan. Accordingly, there is a suspension of repayments against life insurance, building society contracts or securities or fund savings plans.
The repayment itself is only suspended in order to save capital in a life insurance policy, a building society contract or in an investment fund. The level of the loan of course remains the same for the entire term of the contract. If, on the other hand, the final loan is terminated prematurely, for example because the borrower can no longer service the interest payments because he wants to repay his loan earlier than planned, then the loan amount is due in this case at the respective termination date. This results in both advantages and disadvantages for the final loan.
advantages and disadvantages
|Advantages of a final loan||Disadvantages of a final loan|
|The borrower has little financial burden because he only has to pay the interest payments during the term.||Those who can not predict with almost certainty that the proposed repayment vehicle will bring a better return than the loan costs the borrower, should avoid it.|
|High flexibility, as it is possible for the borrower to make other investments until the end of the term.||A loan that runs for 20 years must ultimately repay what the borrower hopes for after 20 years. It is always a risk.|
|There are always advantages if the interest on the respective form of savings is higher overall than the interest payable on the loan.||Borrower needs product knowledge as only certain investment products are suitable for the repayment of maturing loans (i.e. no life insurance)|
|Depending on the type of contract, the interest can be fixed or variable.||The interest rates of the banks are almost always higher with a final loan than with an annuity loan.|
|Interest on the final loan can be offset against the rental income.||In many cases, the capital investment does not fall due at the same time as the final loan.|
During the term of the final loan, the borrower can at any time pay all of his free capital into life insurance or another form of savings. The borrower can claim the resulting income before the end of the loan term. In this way, the borrower is also able to interim finance a larger amount. The final capital, on the other hand, is then settled again exclusively from income from life insurance.
Therefore, mortgages are often offered in mortgage lending. This period is bridged by a final loan so that, for example, a life insurance due immediately does not have to be terminated or a home loan savings contract that becomes due in a short time can be used accordingly. If the building society contract is then ready for allocation or the life insurance is due, it is used immediately to repay the final loan. However, certain experiences are required for the borrower. For example, considerable returns can be generated with securities. This income is often greater than the interest on the loan. However, the tenor is based on the words “let” and “are”, which ultimately means nothing other than that this form of loan is only suitable for risk-tolerant investors.
Because those who speculate also have to reckon with the fact that a not considerable part of what has to be spent on the repayment is missing. Because nobody can predict the exact amount paid out by a fund or life insurance company. Real estate financing alone poses a certain risk, and no one can take a look into the future today. What’s in 10 or even 20 years? Therefore, real estate finance providers should not take more risk than is absolutely necessary. Therefore, classic forms such as home loan or annuity loans should be chosen, perhaps in combination with current subsidies. For example, in the case of an annuity loan, the money is repaid in fixed monthly installments (consisting of an interest and repayment component) until the loan matures.
Annuity loan instead of final loan
Thanks to low interest rates, annuity loans as the standard case of construction finance are currently clearly preferable to a final loan with savings through funds or life insurance. Yields, which have been falling for years, make it difficult to predict the expiry date of a life insurance policy, and it is also not possible to provide a reliable forecast of the performance of funds over periods of ten to 20 years.
Our tip: Use the current low interest rates and choose an annuity loan with full repayment during the fixed interest period. As our mortgage calculator shows, this way you can finance 200,000 USD over 20 years with interest of less than two percent per year and a monthly charge of less than 1,000 USD:
When are final loans used?
Real estate financiers often already have building society contracts or (capital) life insurance policies whose capital could be used for financing. But for that they would have to be due or ready for allocation. If the contracts, which had been in place for years, were canceled, severe losses would have to be accepted. In this case, part of the loan can be taken out without repayment. The capital payment, on the other hand, is used for repayment when it is due. This type of loan is also referred to as so-called interim financing. In this case, the credit contract runs until the contract becomes due.
For example, a loan amount of $ 35,000 is taken up, which is then to be repaid as a final loan but only in 6 years. Interim financing usually bridges part of the amount to be raised, which should actually be covered by equity. An interim financing loan is also not repaid, so that even after a longer term, the entire loan amount is due in the end.
As a rule, the borrower who does not want to act speculatively opens a savings account. The monthly installments paid in by the borrower are then saved first and then used to repay the loan at the end of the term. In order to repay the loan, the repayment of a final loan is completed in parallel.
Borrowers should not only rely on a fixed interest rate guarantee for the entire term, but also choose a secure savings account. Fund savings plans, on the other hand, can not only lead to a capital surplus, but also to a catastrophic scenario. On the other hand, the client can use a clever and profitable investment to shorten the total term of the final loan, in part considerably, compared to an annuity loan. This happens solely because the return on the investment is often much higher than the regular repayment of the annuity loan. On the other hand, every borrower should be aware that each annuity payment with annuity loans has a direct impact on the loan balance and thus on the amount of interest accrued for the next interest calculation.
As a result, the repayment portion of a loan with the same annuity increases over time. Conversely, the interest charge on a maturing loan always remains the same. If, on the other hand, the final loan is financed at an interest rate of, for example, 4.5 percent and the repayment saved in parallel generates an interest rate of 5 percent, then a final repayment can be profitable. The respective decision always depends on the personal situation of the borrower.
In addition to unit-linked life insurance, pension insurance and investment funds are also preferred investment models as savings plans that are used in parallel with the loan agreement over the entire term. Despite the use of existing investments, one fact must not be neglected:
The borrower has to pay interest on the full loan amount over the entire term, so that this system has to compensate for the additional financing costs compared to the annuity option. Example calculation:
|1st installment: 400 USD||Interest portion: 400 USD||Redemption share: 0 USD||10,000 USD|
|2nd installment: 400 USD||Interest portion: 400 USD||Redemption share: 0 USD||10,000 USD|
|…||…||Redemption share: 0 USD||10,000 USD|
|last installment:||Interest portion: 400 USD||Redemption share: 10,000 USD||0 USD|
Fig. “Final loan”: Only interest is paid over the entire term, repayment is made in one sum at the end of the term. The amount of interest payments will therefore not be reduced during the entire term!
The fact that the interest component is initially higher is due to the fact that interest is only due for the remaining debt. As a result, however, the repayment portion decreases in the course of the repayment. Although the loan rate for a final loan consists of an interest and repayment component, only the interest is paid during the repayment phase, but the repayment component is saved. This, in turn, has the advantage that the term of a final loan is usually shorter than that of a loan with ongoing repayment.
Who are final loans suitable for?
A final loan is generally only sensible for rented properties, because here the borrower can use his interest on the external financing for tax purposes against the income from renting and leasing. However, if you live in your own home, there is no tax deductibility, so choosing an annuity loan is the better alternative. A final loan, i.e. financing with a consistently high interest charge, also pays off for builders if this is combined with a home loan savings contract, in order to secure the interest for follow-up financing early on. The same applies if investors combine financing with life insurance in order to deduct interest from tax.
A final loan also offers advantages in the event that securities have already been invested in the past, as this saves the builder from having to repay the monthly charge. Since the claims of the funds made available for the repayment of the loan must be assigned to the financing bank, it is particularly important for builders with life insurance that the surplus amounts obtained from life insurance remain tax-free even after the assignment to the bank. Therefore, a tax advisor should be consulted before the transfer.
Anyone who can expect an inheritance or the receipt of a fixed investment can also benefit from this type of loan. Since this form of loan is also finally due, the borrower primarily has a smaller monthly charge because the expenses for the repayments are eliminated. The big disadvantage of a final loan, however, is the high final rate – an often incalculable risk. On the other hand, the following applies again: depending on which repayment surrogate (home savings contract, life insurance, bank savings plan, etc.) is chosen by the borrower, there is even the possibility that certain savings benefits may even be subsidized by the state. In this way, the capital can be increased even faster. Therefore, borrowers should always include a special repayment option when making a final loan. However, these must be specially agreed with the bank.
Special repayments can also be terminated at any time with variable interest with a three-month notice period. If you can no longer meet your repayment, your bank will quickly cause problems, because the bank is entitled to make the claim due. The legal consequence of the due date is that the bank can utilize the mortgage rights ordered as security. A prerequisite for the realization of loan collateral is the maturity of the claims for which they were made. A bank can only apply foreclosure measures, such as auctioning, based on due claims.
The extraordinary right of termination is regulated in § 490 BGB. According to Section 490 (1) BGB, the loan can be terminated in the event of (impending) deterioration in assets. The borrower also has an extraordinary right of termination if the property lent is used for other purposes and if a prepayment penalty is paid (section 490 (2) BGB). As a rule, the bank is entitled to a special termination right if the customer’s economic situation has deteriorated significantly, if he is in default with the repayment of the loan (usually with two or three installments) or if the value of the collateral provided deteriorates significantly Has. However, these aspects must be checked carefully in each individual case.
Every risk also carries its own danger. For example, if an investment does not develop as expected, the borrower may pay extra. This would be the case, for example, if the yield is correspondingly lower than the loan interest. If the value of an investment at the end of its loan term is even lower than that of the loan debt, there is a huge hole in the financing. If this hole also needs to be plugged, then the entire funding will no longer be sustainable for most. Because one very important point must never be overlooked: in the case of a final loan, the entire loan amount must be paid in full in one sum at the time of final maturity. Example:
In particular, due to the current reduction in the mandatory surpluses, many mortgage lenders in Germany are facing exactly this problem. The same problem would exist if the market interest rate for an annuity loan was 6.5 percent. Now, however, the yield of the repayment must be saved in parallel for each final loan. But if this return is only 5 percent, choosing a final loan would be bad business. On the other hand, if the market interest rate were 4 percent, the borrower could even make a profit. A final loan is therefore not dependent on the question “whether and if so, when?”, But only on the amount of the current market interest rate.
Investors or borrowers, on the other hand, should never use the final loan within a real estate loan for speculative purposes, because nobody can predict a certain increase in value. If the development turns out to be different than expected, the entire real estate business will soon collapse.
Tax aspects of final loans
Borrowers who use life insurance as a repayment vehicle must note the following: Income generated from this policy is only tax-free if the insurance was taken out before 2005 and for more than twelve years. In all other cases, all income – with the exception of a payment after reaching the age of 60 – is subject to tax. In addition to the agreed sum insured, the maturity payment for which taxes have to be paid also consists of the guaranteed minimum interest rate and possible but not guaranteed surpluses. Borrowers are therefore encouraged to agree a correspondingly high sum insured for a final loan through life insurance so that this amount is also sufficient – after tax deduction – for the final repayment of the loan.
Anyone who rents out their property can also deduct their interest on financing for tax purposes as an investor. A tax advantage can also arise when renovating rented properties due to the relatively high interest rates on a final loan.
In addition to the stability in value and the income opportunities from rental income, real estate is also interesting from a tax perspective. In the case of rented properties, certain advertising costs can be offset against the corresponding rental income. If the advertising costs exceed the rental income, there are “losses from renting and leasing”, which can be claimed for tax purposes. The advertising costs include, for example: the financing costs (interest on loans, ancillary costs and fundraising costs), depreciation (deduction for wear and tear = depreciation), maintenance costs, and other advertising costs. In addition to the interest on debt, the incidental financing costs include the loan commission, commitment interest and estimation fees; Fundraising costs include court and notary fees as well as an agreed discount.
Real estate loses value through its use. As a landlord, you can claim this loss in value by reducing the acquisition and production costs as well as incidental costs (e.g. brokerage commission, notary and court fees, real estate transfer tax and ancillary construction costs) over the years of use and offset against the rental income. Since land usually does not lose value, only the costs incurred by the building and the proportional incidental acquisition costs may be written off. The tax office also contributes to the costs of renovation work. A distinction must be made between immediately deductible maintenance costs and production costs. The latter may only depreciate landlords over the years of use.