What to do if interest rates rise?

What to do if interest rates rise?
Written by insideindyhomes

Status: 05/10/2022 08:48 a.m

Rising interest rates are making the dream of owning your own four walls more expensive. Many home builders and homebuyers want to take advantage of the still cheap loans. But experts warn against hasty decisions.

By Notker Blechner,

The phones are currently running hot at building societies and mortgage lending brokers. Since the beginning of the year, the already strong demand for construction loans has increased further. Many people fear that interest rates and real estate will soon become even more expensive. According to its own statements, the Landesbausparkasse Bayern has committed over 70 percent more money to loans in the first four months of the year. The LBS West reports an increase of 50 percent. Banks are also reporting double-digit growth rates in their mortgage lending business.

High demand from intermediaries

Demand has also increased sharply among financing brokers, who mostly process construction loans online. “The number of inquiries and transactions in 2022 has so far been significantly higher than in the last few months of last year,” said Mirjam Mohr, board member at the nationwide financing broker Interhyp, at the weekend.

Since Christmas, building interest rates have risen more than they have since 1999. The cost of 10-year fixed-rate loans has more than doubled. While interest rates for ten-year loans were still 0.9 percent in December 2021, they are now 2.6 percent, according to Interhyp.

Interest rates more than doubled

Because the construction interest does not depend on the key interest rate of the European Central Bank (ECB), which is still zero percent, but on the development of federal bonds. And the turnaround in interest rates can already be felt there. Last week, the yield on ten-year Bunds climbed above the one percent mark for the first time in seven years.

Since the US Federal Reserve will continue to raise interest rates and the ECB will soon herald a turnaround in interest rates, construction interest rates are likely to rise further in the coming months. Experts like Max Herbst from FMH-Finanzberatung in Frankfurt are already expecting a level of three percent in the summer months. “Inflation is pulling construction interest rates up. If the ECB raises key interest rates in July, this will trigger another small upward movement,” says Herbst And there is still no sign of a stop to the rising construction interest rates.

400 euros higher costs per month

Higher interest rates make loans more expensive. “The rise in interest rates for ten-year loans from one percent at the beginning of the year to currently around 2.6 percent means that with a real estate loan of more than 300,000 euros and an initial repayment of three percent, the monthly rate has risen from 1,000 euros to 1,400 euros – i.e. by 400 euros a month,” says Interhyp board member Mohr. “These are additional interest costs of 4,800 euros per year.”

So what should you do if you are planning to build or buy a home and need a loan? Experts recommend not rushing into construction financing. “Each interest rate increase at current real estate prices and the resulting high loans does cost a lot of money, but the wrong property, bought hastily or signed for, can cause even more trouble and expenses,” warns financial expert Max Herbst from FMH. Under no circumstances should you buy the next best thing or let yourself be pressured by a bank.

Experts recommend longer fixed interest rates

“Even in the current environment of rising interest rates, we advise approaching the financing carefully and comparing offers carefully,” says Mirjam Mohr from the Interhyp board. Interested parties should know that the second decimal place of the construction interest changes almost daily. However, as soon as there is a concrete offer from a lender, this is valid for five to ten days – depending on the bank. “During this time, all necessary documents must be submitted to the bank, otherwise this interest rate offer expires.”

Interhyp board member Mohr advises anyone who has opted for construction financing to make a higher initial repayment and longer fixed interest rates. “Buyers should secure the interest rates, which are still low by historical standards, for as long as possible, ideally for 15 years or more.” Financial advisor Max Herbst also recommends that those who finance the monthly burden should opt for the more expensive long-term fixed interest rate in order to be protected against higher interest rates.

“Forward loans” to secure low interest rates

Anyone who is already in financing and will soon have to extend their loan should use the current interest rate level for follow-up financing. According to experts, so-called forward loans are particularly useful here. “With forward loans, favorable interest rates can be secured for the future, even up to five years in advance,” explains Interhyp board member Mohr. A certain interest premium, the “forward premium”, is calculated for the lead time. Forward loans are often not much more expensive than today’s loans. “Six to twelve months in advance, there is often no surcharge.”

But one thing is clear: the rising mortgage interest rates will lead to higher costs for home builders and homebuyers in the medium term. They “are likely to reinforce the trend that not everyone who wants to build can afford financing,” warns Ditmar Rompf, head of the financing broker Hüttig & Rompf. Even a small increase in interest rates could increase the monthly burden by several hundred euros. “People who could only afford to buy real estate in recent years because of the extremely low interest rates are now falling out of the market,” agrees Ludwig Dorffmeister, a construction and real estate market specialist at the Munich Ifo Institute.

Is a real estate bubble looming?

The German financial regulator BaFin is concerned about the piled-up risks in the real estate market. When interest rates rise, demand for residential real estate falls, said Bafin boss Mark Branson recently at the authority’s annual press conference. As a result, prices could fall and with them the value of the collateral. So is the stability of the real estate market at risk?

The Association of German Pfandbrief Banks (VDP) does not see it that way. The credit burden ratios, i.e. the relationship between the expenditure on interest and repayment and the disposable household income, are currently increasing. “But we think it’s wrong to warn about a real estate bubble now,” says VDP President Louis Hagen. Despite the increase, the costs are still well below the level of the 1970s and 1990s. Back then, people had to work far longer for their own property than they do today. In the 1990s, the loan load ratio was 38 percent. Today it is 25 percent.

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