Debt capital: important factor for loan conditions

by Admin | March 29, 2021
Debt capital: important factor for loan conditions

Most real estate purchases are not covered 100 percent by equity. As a rule, a large part of the purchase sum is paid with borrowed capital. Debt capital is a loan provided by third parties that must be repaid by the borrower. Capital providers can be banks, companies or even private individuals. If you are interested in taking out a loan, you should carry out a loan comparison.

In contrast to pure real estate financing, borrowers have the option of reducing the debt capital portion of construction financing through personal contributions. For example, work on the interior or exterior can be carried out by the builders themselves. This reduces financing costs. If the equity ratio remains high, the amount of borrowed capital required falls.


Proportion of debt and equity decisive

Every real estate financing represents a risk for a bank. The more equity a borrower has available and the less money he has to borrow, the lower the risk for the bank. Borrowers should therefore try to keep the proportion of debt capital as low as possible.

If a borrower has a lot of equity, both the term and the monthly installment payment on the real estate loan can be reduced. If the term is shortened, the bank gets its money back more quickly; if the loan installment is reduced, the default risk is lower while income levels remain the same.

At least 40 percent equity

It is advisable to have at least 40 percent equity in order to benefit from particularly favorable interest rates for real estate financing. The distribution of 50 percent equity and 50 percent debt is considered particularly favorable, because this is usually the best possible interest rate in relation to the debt capital.

From 60 percent debt capital it becomes significantly more expensive

As a rule, banks stagger the interest rates on the basis of the equity capital contributed. Today, borrowers can also finance without equity capital. However, they must then reckon with significant interest surcharges. Interest rates can rise significantly from a ratio of 60 percent debt to 40 percent equity. The next threshold for most banks is 80 percent debt.

Increasing the proportion of borrowed capital also means that not only does the interest rate change, but repayment of the loan is extended or the monthly installments become higher.

Why equity makes sense

The more of a borrower's own money he can raise for the purchase or construction of a property, the safer it is for banks to provide debt capital.

You should raise at least 20 percent of your own capital to have any realistic chance of getting good credit terms. For a real estate price of 200,000 dollar, that's 40,000 dollar.


Reasons why a lot of equity makes sense:

  • Borrowers get more favorable interest rates.
  • Homebuyers have the chance of a shorter term.
  • Smaller monthly installments have to be repaid.
  • Repayment is faster.
  • The security for the bank is greater.

The conditions for the real estate loan usually improve with the amount of equity. From an equity ratio of 40 percent, there are usually more favorable interest rates. Interest rates fall because this reduces the risk of loan default for the bank.

When equity should be retained

In some cases, it may make sense not to wait until an equity ratio of 40 percent is reached. For example, property prices may rise significantly until the future homebuyer has saved the necessary amount for equity.

For example, if a property once cost 250,000 dollar, the purchase price for a similar property two years later may already be 290,000 dollar. If the consumer has managed to put aside 40,000 dollar during this time, the increase in price will eat up his equity. The consequence would be that he would have to finance more despite his own capital.

In times of sharply rising real estate prices and low interest rates, financing with less equity can sometimes make more sense than waiting until sufficient equity has been accumulated. The prerequisite for good credit conditions in this case is a sufficient credit rating of the borrower to present collateral to the bank.

Borrowed capital for construction financing

Debt capital is also provided by third parties for construction financing. On the one hand, it helps to bear the overall costs, but on the other hand, it can also be used to finance individual construction phases or extensions. In contrast to real estate financing, there is a wider choice of possible lenders for construction financing.


Lenders for construction financing

Loans or mortgages from banks

Construction financing can be supported by mortgages or loans from banks. The terms are usually different from buying real estate, as it is often a greater risk for the bank to invest in new real estate than in existing buildings.

Programs from public development banks

Development banks such as the Kreditanstalt für Wiederaufbau (KfW) finance special construction projects. Borrowers can apply for the development funds there and supplement their construction financing through banks. The money from KfW and other development programs is earmarked for a specific purpose and cannot be used elsewhere. Subsidy programs are usually characterized by very favorable loan conditions.

Private individuals

Debt capital can also be provided by friends or relatives. For example, parents often help their children with construction financing. In some cases, this is possible through an advance on the inheritance or the parents take out a mortgage on their own home.


The so-called employer loan can be used by employees if the company offers such a loan. The advantage of this external capital is that it is usually associated with far more favorable interest rates than a bank loan. The possible loan amount and the interest rate usually depend on the length of service.

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