Real estate financing: cap loans – variable loans with security

The idea behind it

The idea behind it

Cap loans are a form of variable loan. The borrowing rate is adjusted every three or six months to the current interest rate based on the Good Finance. If necessary, for example when interest rates have dropped, the property owner can have the loan converted into an annuity loan with long-term fixed interest rates. The difference to the Good Finance loan is that cap loans have an interest cap. The contract sets a specific interest rate that the borrower must pay at most.

Depending on the contractual agreement, the borrower is protected against a rise in interest rates beyond the cap for a period of, for example, 3, 5, 10 or 15 years. Example: The customer signs a loan contract with the bank for a term of 5 years with variable interest rates. While the interest rate for this term is currently 2.5 percent, the maximum interest rate is set at 4 percent. If interest rates rise to 5 percent in the next 5 years, the borrower will still only pay 4 percent, namely the specified upper limit. If market interest rates fall, the interest rate is corrected downwards.

Securing costs cap fee

Securing costs cap fee

The providers charge additional costs for the interest rate limit. The bank adds the so-called cap premium to the loan interest. The amount depends on the provider and the contract: the longer the contract and the lower the upper limit, the higher the cap premium, which increases the annual percentage rate. Depending on the agreement, it adds up to two or three percent of the loan amount, making the loan more expensive.

In addition, the loan to limit interest rate cuts can be equipped with an interest floor (floor) below which the interest rate of the loan cannot fall. The borrower then benefits from falling interest rates only up to the specified lower limit. A floor in turn reduces the cost of the cap. Products for which both a cap and a floor have been agreed are referred to as collar loans.

Special advantages

Special advantages

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The advantage of cap loans is that the borrower can make special repayments on every interest rate adjustment date or can repay the loan in full without incurring prepayment penalties. Compared to Good Finance loans, they are also associated with a fairly high level of calculation security. The interest cap gives the real estate buyer an interest rate security similar to that of a classic loan with a corresponding fixed interest rate. So he doesn’t have to keep an eye on the financing to get out at the right moment.

When are cap loans suitable?

When are cap loans suitable?

This type of financing is more worth considering in periods of low interest rates when rising interest rates can be expected. A cap loan is particularly worthwhile if the property buyer expects a larger inflow of money and keeps the option for the highest possible repayments, but still does not want to forego a certain amount of security. In this case, it can be concluded as an addition to a medium or long-term fixed loan. However, if the property owner repays the cap loan very quickly, it is relatively expensive due to the cap fee.

Since the interest rate level is currently historically low, there is also the alternative of taking out an annuity loan with a short fixed interest rate of between one and five years and then repaying the remaining debt with the special funds that are then available.

Another variant are combination loans, which consist of a variable part of the loan without a cap and a fixed-interest loan. The costs for the upper limit of interest do not apply here, but the risk for the variable loan component is also higher.