Debt

Debt capital is the portion of financing for a real estate purchase or construction project that does not come from the buyer’s own funds but is raised through loans from banks, building societies, or development banks. Unlike equity, debt capital must be repaid with interest and repaid within an agreed-upon period. The debt-to-equity ratio is one of the most important metrics in real estate financing and significantly influences terms, risk, and return.

Debt in Real Estate Financing

In a typical residential real estate financing arrangement in Germany, debt accounts for 60 to 90 percent of the purchase price. Banks calculate the so-called loan-to-value ratio (LTV): the ratio of the loan amount to the market value of the property. The higher the LTV, the greater the risk for the bank and, as a rule, the higher the interest rate. If debt and thus the LTV exceed 80 percent, many banks require risk premiums or residual debt insurance.

The main types of debt financing in real estate:

• Annuity loan: Fixed monthly payment consisting of interest and principal; the most common type
• Variable-rate loan: Interest rate adjusts to market conditions; suitable for shorter terms
• KfW subsidy loan: Low-interest supplementary financing for energy-efficient construction and renovation
• Building savings loan: Combines a savings phase with a low-interest loan at a fixed interest rate

Borrowing costs and tax deductibility

The costs of debt financing-i.e., interest and processing fees-are tax-deductible as income-related expenses against rental income for rental properties (§ 9 EStG). For owner-occupied properties, the tax deductibility of interest in Germany is no longer possible since the elimination of the Baukindergeld. This is a significant tax difference between rental investment properties and owner-occupied residential property.

In addition to ongoing interest, other borrowing costs can also be claimed as income-related expenses:

• Commitment fees: Incurred when the credit line is made available but has not yet been fully drawn down
• Disagio (Damnum): A discount deducted in advance that lowers the effective nominal interest rate; can be deducted over the term of the loan
• Notary fees for the creation of a land charge: Deductible as income-related expenses for rental properties
• Early repayment penalties: Deductible as income-related expenses under certain circumstances if the property is sold or refinanced after the loan is paid off

The Leverage Effect: Debt as a Return Lever

Real estate investors deliberately use debt as a return lever (leverage effect): If the property’s return is higher than the interest rate on the debt, the return on equity increases as the amount of debt used rises.

Example: With a rental yield of 5 percent and a debt interest rate of 3 percent, debt significantly increases the return on equity-someone who invests 100,000 euros of equity with 80 percent debt financing achieves a much higher return on equity than when purchasing without a loan. If the ratio is reversed (interest exceeds return), the leverage effect has a negative impact-a risk that should always be taken into account in financial planning. During periods of rising interest rates, such as from 2022 to 2024, this exact scenario has materialized for many highly indebted investors.

Debt Capital and Loan-to-Value Ratio

Banks determine a property’s appraised value using conservative standards, which typically fall 10 to 20 percent below the purchase price. This allows them to hedge against fluctuations in the real estate market. The loan-to-value limit-that is, the maximum loan amount as a percentage of the mortgage lending value-is 80 percent at most banks (first-lien mortgage). Any amounts exceeding this are secured on a subordinate basis and subject to interest rate premiums.

For buyers, this means: Even if the purchase price is 500,000 euros and the mortgage lending value is 450,000 euros, the bank may limit the loan to a maximum of 360,000 euros (80 percent of the mortgage lending value) at first-lien terms. The buyer must finance the remainder with equity or subordinated debt.

Practical Tip for Homeowners in Nuremberg and Franconia

In the Nuremberg metropolitan region, purchase prices for residential real estate have risen significantly in recent years. This has substantially increased the amount of debt financing required by buyers-a single-family home in sought-after locations now requires debt financing of 600,000 euros or more. We recommend that our clients consider not only the purchase price but also the incidental purchase costs (real estate transfer tax 3.5 percent, notary fees approx. 1.5 percent, brokerage fee approx. 3.57 percent) when planning their financing-these should be financed from equity whenever possible, as they do not generate mortgageable value.

Comparing at least three financing offers-ideally through an independent financial broker-can reduce total costs over the loan term by tens of thousands of euros. Upon request, we coordinate collaboration with local financing partners in Nuremberg and the surrounding region.

Frequently Asked Questions

How much equity should I contribute when financing a property?

As a rule of thumb: at least 20 percent of the purchase price as equity plus the incidental purchase costs (approx. 10 to 15 percent of the purchase price in Bavaria). Those who contribute less equity pay higher interest rates and bear a greater financing risk. In periods of high purchase prices, such as in the Nuremberg metropolitan area, we recommend not stretching your equity too thin-a financial buffer for unforeseen costs is more important than a minimal equity ratio.

Can I buy a property entirely without equity?

So-called 110-percent financing (purchase price plus closing costs covered entirely by debt) is offered by some banks to borrowers with excellent credit, but it comes with significant interest rate premiums. We generally advise against this, as the financial risk is very high in the event of a decline in property value or loss of income.

How do rising interest rates affect my borrowing costs?

With fixed-rate loans, you are protected against interest rate hikes for the duration of the term. Once the fixed-rate period expires, the follow-up financing must be arranged at the prevailing interest rates at that time. With variable-rate loans, interest rate increases take effect immediately. That is why we recommend the longest possible fixed-rate period for long-term real estate financing-especially during periods of low interest rates, a 15- or 20-year fixed-rate period secures favorable terms in the long run.

What is a forward loan, and when is it worth it?

A forward loan allows you to lock in the terms for a follow-up financing today that won’t be due for another 12 to 60 months. This is worthwhile if rising interest rates are expected and your current fixed-rate period is set to expire in the foreseeable future. The bank charges a small premium for holding these terms-this can pay off if interest rates actually rise.

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