July 6, 2023, 4:40 am | Read time: 4 minutes
Those who already own a home might finance the purchase of another property using the first house. This security often leads to better terms with banks. However, there are also disadvantages.
While housing prices are gradually decreasing, the price level remains high. Additionally, the increased interest rates contribute to expensive construction financing. Those who already own a property are fortunate. They can use it as collateral for a new purchase. Banks favor this for a crucial reason: If the loan for the new property can no longer be serviced, financial institutions can secure themselves with both the financed and additionally mortgaged property. Here are the pros and cons of using a property as loan collateral.
How to Mortgage an Existing Property
The loan amount for the new purchase is partially entered into the land register of the ideally debt-free property. The bank usually takes the first rank, ensuring its claims are prioritized in case of the borrower’s insolvency.
But it’s not just the bank that benefits. Re-mortgaging a house or apartment also improves loan terms for the new acquisition. “With a property in the background, the interest rate is typically lower,” says Helena Klinger from the Institute for Financial Services (iff) in Hamburg. If the land charge for the property to be mortgaged is not yet deleted and the loan for the existing property is either fully or mostly repaid, the new loan can be registered on it.
Family Home Secures the Loan
Adrian Englschalk, a consultant at the Consumer Center of Lower Saxony, mentions two typical scenarios for mortgaging. Either they serve as a substitute for equity when buying a new property, or parents provide a house or apartment to secure a loan for children who wish to build or buy. This option sometimes replaces intra-family guarantees.
According to Englschalk, banks increasingly suggest that children use the parental home as a financing tip. From the children’s perspective, this is sensible. A mortgage is considered equity, and the interest rate decreases. “Money can be saved over the sum and the loan term,” says the consultant.
From the parents’ perspective, however, the solution is very concerning: “If the loan defaults, the mortgaged home is involved.” In the worst case, it is used for repayment.
Support for Equity
Homes serve as equity substitutes when owners invest in one or more additional properties but want to contribute little from their own pockets. Among professional investors building a larger portfolio, this type of financing is common.
But private property owners are also increasingly taking out mortgages on their homes. Banks and building societies are on board. Mortgaging “existing residential properties as part of planned financing is common practice,” says the Association of Private Building Societies. The association also knows this instrument from financing vacation properties abroad. In such cases, the property to be mortgaged must be located in Germany.
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Mortgage to Modernize
Private investors can generate tax benefits in addition to interest advantages by mortgaging the old property, especially if they rent out the newly acquired one. “Then the interest expenses can be deducted from income tax,” says Frank Lösche from the real estate financing broker Dr. Klein. However, one should consider: Those who mortgage their property to acquire new real estate risk their own home if the loan is no longer serviced. The bank can use it for repayment in case of default.
Helena Klinger from the iff has a third mortgage option in mind: to obtain liquidity for modernizing the home. Banks usually offer annuity loans for this purpose. For amounts starting at around 50,000 euros, using an existing land charge can be a worthwhile financing alternative, Klinger suggests.
Weighing Opportunities and Risks
Those considering a mortgage should seek solutions and offers from multiple financiers before deciding. This is partly due to the mortgage value. According to Frank Lösche, it is assessed differently, leading to significant interest rate differences.
Typically, the existing property, including the new loan, is mortgaged up to 85 percent. For example, at only 75 percent, significantly more money must be raised over the years. Regardless, both financial institutions and building societies check the borrower’s creditworthiness–just like with a traditional mortgage.
Under favorable conditions, mortgaging one’s property is especially sensible due to interest savings. This is offset by the risk factor of potential property loss. Buyers should weigh both points against each other and seek advice on the details.
With material from dpa