Interest rate risk

Interest rate risk refers to the risk that a change in general interest rates will result in a financial disadvantage for property owners or investors-particularly when refinancing a real estate loan, when the agreed-upon fixed-rate period ends and the loan must be renewed under new terms. If market interest rates rise significantly in the meantime, the monthly interest burden after the extension may be considerably higher than originally calculated. Interest rate risk is one of the key financing risks in the real estate sector.

Origin and Mechanism of Interest Rate Risk

Real estate financing in Germany is typically arranged with a fixed-rate period of 5, 10, 15, or 20 years. During this period, the borrowing rate remains unchanged. When the fixed-rate period expires, the remaining loan balance must be refinanced at the market interest rates in effect at that time.

Anyone who financed at 1.0 to 1.5% during periods of low interest rates (such as 2010 to 2021) and is now renewing at 3.5 to 5% will face a significant additional burden: With a remaining debt of 200,000 euros and a remaining term of 10 years, a 3-percentage-point increase in interest rates corresponds to an additional monthly burden of approximately 500 euros. The interest rate risk is thus a real household risk, not a theoretical concept from textbooks.

The impact of interest rate risk depends on three factors: the amount of the remaining debt at the time of renewal (the higher the amount, the greater the risk), the length of the remaining term after renewal (a longer term means longer exposure), and the actual change in interest rates between the initial agreement and renewal.

Hedging Strategies

Homeowners can employ various strategies to hedge against interest rate risk: A long fixed-rate period (15 to 20 years) locks in the current interest rate for an extended period and limits the risk. Repayment optimization-a higher initial repayment rate-reduces the remaining debt at the time of renewal and thus the amount exposed to interest rate risk.

Forward loans allow you to lock in the renewal interest rate up to five years in advance-for an interest premium of typically 0.01 to 0.03 percentage points per month of lead time. If an interest rate increase of more than 0.5 percentage points is expected, a forward loan usually pays off. Finally, refinancing with another provider can be used for renewal to secure better terms through competition. Those who compare options early have more room to negotiate than those who act under time pressure shortly before the expiration date.

Significance for Investors and Capital Investors

For real estate investors, interest rate risk is particularly significant, as the return on an investment depends directly on the financing interest rate. A property that generated a positive cash flow return at a 1.5% financing interest rate can slip into a negative monthly balance at 4.5%-if rental income does not offset the increased interest costs.

Investors with multiple loans should stagger renewal dates to avoid having to renew all loans simultaneously at an unfavorable interest rate. This staggering-also known as an interest rate ladder-is a proven tool for active risk management in a real estate portfolio.

Practical Tip for Property Owners in Nuremberg and Franconia

The ECB’s interest rate hikes starting in 2022 have made the interest rate risk very real for many Franconian property owners who secured financing during the low-interest-rate period. Anyone facing a loan renewal in the next one to three years should act now: explore forward loans, obtain and compare multiple bank offers, and assess whether early repayment of the current loan (subject to a prepayment penalty) makes financial sense.

In the Nuremberg metropolitan area, local credit unions, savings banks, and direct banks are competing for renewal customers-and you can take advantage of this competition. We’d be happy to connect you with experienced financial advisors in the region who can compare and negotiate across banks.

Frequently Asked Questions

How long should I choose for my fixed-rate period?

That depends on current interest rates and your personal risk tolerance. During periods of historically low interest rates, longer fixed-rate periods (15 to 20 years) are recommended to secure favorable terms in the long term. During periods of high interest rates, shorter fixed-rate periods can be attractive in the hope that rates will fall-though the borrower bears the risk that rates may continue to rise. A rule of thumb: The premium for a 20-year fixed-rate period compared to a 10-year period is typically 0.2 to 0.5 percentage points-a favorable insurance premium against interest rate risk.

What is a forward loan and when is it worthwhile?

A forward loan allows you to lock in the subsequent interest rate years before the current fixed-rate period expires. The premium for the advance period is typically 0.01 to 0.03 percentage points per month of advance time. It is worthwhile if you expect interest rates to rise and prefer planning security. With a 24-month advance period, this means a premium of approximately 0.24 to 0.72 percentage points-which is worthwhile if interest rates rise by more than this amount by the time of renewal.

Can I prepay my loan to avoid interest rate risk?

Fixed-rate loans can be terminated after 10 years in accordance with Section 489 of the German Civil Code (BGB) with six months’ notice and without prepayment penalties. Within the ten-year period, termination is only possible upon payment of an early repayment penalty that compensates the bank for the lost interest income. This penalty can be substantial-careful calculation is absolutely essential before terminating the loan early.

What is the difference between interest rate risk and liquidity risk?

Interest rate risk refers to the danger of rising interest rates during refinancing. Liquidity risk refers to the danger that short-term payment obligations (installments, ancillary costs) can no longer be met-regardless of the interest rate level. Both risks are interrelated: Rising interest rates increase the monthly burden and can exacerbate an existing liquidity risk. Good financial planning takes both dimensions into account.

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