Debt-to-equity ratio

Loan-to-Value Ratio - The loan-to-value ratio (LTV) indicates the ratio between the amount of debt financing and the value of a property. It is calculated by dividing the loan amount by the property value and expressed as a percentage. An LTV of 80 percent means that 80 percent of the purchase price is financed with debt and 20 percent with equity. The debt-to-asset ratio has a decisive influence on the interest rate, risk, and return of a real estate investment.

Impact on Financing Terms

Banks tier their interest rates based on the loan-to-value ratio-the ratio between the loan amount and the appraised value, whereby the appraised value is typically slightly below the purchase price:

• Up to 60 percent loan-to-value ratio: real estate loan terms, lowest interest rate
• 60-80 percent: slight interest rate premium (approx. 0.1-0.3 percentage points)
• 80-90 percent: significant premium (approx. 0.3-0.6 percentage points)
• Over 90 percent: high premium (0.5-1.0 percentage points) or rejection

These interest rate premiums add up significantly in a typical financing scenario: For a loan of 300,000 euros with a 0.5 percentage point premium, the borrower pays approximately 1,500 euros more per year-over a 20-year term, that amounts to 30,000 euros in additional interest costs. A higher down payment can therefore be worthwhile even if the equity could be invested elsewhere to generate a return.

With full financing (100% financing), the entire purchase price is financed; with 110% financing, the ancillary purchase costs (real estate transfer tax, notary, real estate agent) are also included. Both options are only available to those with excellent creditworthiness and a stable income and come with significant interest rate premiums.

Leverage Effect in Real Estate Investments

For investors, the debt-to-equity ratio is a strategic tool: The leverage effect states that the return on equity increases as long as the loan interest rate is lower than the property’s total return. A calculation example illustrates this:

Property with a 5 percent total return on 400,000 euros = 20,000 euros in annual income. With 50 percent equity (200,000 euros) and a loan interest rate of 3 percent on 200,000 euros (6,000 euros in interest), a net income of 14,000 euros remains on 200,000 euros of equity-a return on equity of 7 percent. If the equity share is reduced to 20 percent (€80,000) and the interest rate remains at 3 percent on €320,000 (€9,600 in interest), the return on equity increases further.

However, the leverage also works in reverse: If interest rates rise during refinancing or the property value falls, the equity can be quickly depleted with a high debt-to-equity ratio-potentially resulting in negative equity. During the 2022/2023 interest rate hike phase, it became clear that investors with extremely high debt ratios and short-term fixed-rate periods can run into significant liquidity problems.

Debt Ratio and Cash Flow Planning

When calculating the optimal debt ratio, the monthly cash flow must not be overlooked. A high LTV means higher interest costs and principal payments, which must be covered by rental income. If the rental yield is insufficient to finance debt service, management fees, the maintenance reserve, and the vacancy reserve, a negative cash flow results-the investor must make additional monthly payments.

As a rule of thumb, we recommend that net rental income should cover at least 110 to 120 percent of the monthly interest and principal payments. This buffer provides protection against rent defaults, unforeseen repairs, and interest rate increases upon loan renewal.

Practical Tip for Property Owners in Nuremberg

We recommend that real estate buyers in the Nuremberg metropolitan area aim for a debt-to-value ratio of no more than 80 percent-ideally lower. For a typical condominium in Nuremberg with a purchase price of 350,000 euros, an LTV of 80 percent means a loan of 280,000 euros and equity of 70,000 euros plus approximately 28,000 euros in closing costs-a total equity outlay of around 98,000 euros.

In Nuremberg neighborhoods with stable rent levels-such as Johannis, Gostenhof, or Maxfeld-the cash flow situation is often barely positive at an 80 percent LTV and current purchase prices. Those who finance more than 80 percent often end up in negative cash flow territory. Investors can utilize a higher debt-to-equity ratio, but should carefully calculate the cash flow and maintain a liquidity reserve of at least three to six months’ worth of payments.

Frequently Asked Questions

What is the optimal debt-to-asset ratio?

For owner-occupiers, experts recommend an LTV of 70-80 percent-this offers a good balance between a favorable interest rate and an appropriate risk buffer. For investors, a higher LTV (80-90 percent) can make sense due to the leverage effect, provided that cash flow remains positive and a sufficient liquidity reserve is available. An LTV above 90 percent is only advisable if a high and stable income secures the payments in the long term and a potential price decline would be financially manageable.

What happens with negative equity?

Negative equity (also called “underwater”) means that the remaining debt exceeds the current property value. This can occur with high debt levels and market declines. As long as you make your payments, this has no immediate consequences-but it becomes a problem if you need to sell (the proceeds do not cover the remaining debt), refinancing is due (the bank re-evaluates the collateral and may demand worse terms or an additional equity injection), or unexpected liquidity shortages occur. In Nuremberg, this risk is historically low with an LTV below 80 percent, as property prices have not experienced extreme slumps even during market corrections.

Do banks factor in ancillary costs when calculating the debt-to-value ratio?

Banks generally use the appraised value (which is more conservative than the purchase price) as a benchmark. The ancillary costs (real estate transfer tax of 3.5 percent in Bavaria, notary fees of approx. 1.5-2 percent, real estate agent fees of up to 3.57 percent: totaling approx. 8-10 percent of the purchase price) are not included in the mortgage lending value-they must be financed from equity. An LTV of 80 percent based on the purchase price may therefore correspond to a higher effective loan-to-value ratio if the bank’s inherent mortgage lending value is below the purchase price. When planning financing, both ratios should therefore always be calculated separately.

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