In times of low mortgage rates, many borrowers are considering how to use this favorable situation for their home finance. In principle, a change in building finance or a change in the interest rate within the current fixed interest period is only possible if the client is willing to pay a prepayment penalty. This is expensive, however, and the change becomes economically uninteresting.
So while there is little scope for structuring the old loan, the building owner has free rein in the decisions relating to follow-up financing: he can decide for himself when to set the current interest rate and with which bank he will regulate the next section of his construction finance – and this while the fixed interest period for his old loan is still running.
How do forward loans work?
A forward loan works like normal follow-up financing – with the special feature that the new interest rate is fixed well before the end of the old fixed interest period – sometimes more than 36 months beforehand.
As with normal follow-up financing, you can take out forward loans from your current bank or switch to another financial institution.
The costs of rescheduling to another bank are so manageable that you don’t have to take them into account in the first step. First of all, it is important to obtain offers for a forward loan at all and to evaluate these offers.
Essentially, this is about assessing future interest rate developments. The longer the time until the start of the forward loan, the less the bank and customer can predict how much interest will rise until the end of the old fixed interest period.
If the interest rate does not rise – or even decrease – compared to the current interest rate level, the loan interest rate of the forward customer is above the current conditions. Because the bank has the early loan approval paid with a forward surcharge.
How high the interest premium depends on how the bank estimates the interest rate development. In previous years, the premium was 0.01 to 0.03 percentage points per month until the old loan was repaid. In May 2019, you can expect around 0.02 percentage points per month.
This is how the interest premium works
The calculation shows: The lower the lead time until payment and the lower the interest premium, the lower the fixed interest rate of the forward loan. When it comes to the purely numerical level, a forward loan pays off if the customer would have to pay a higher interest rate when the old contract was replaced with the same key data – the overall interest rate level has therefore risen.
The transition to a building loan without a forward surcharge is fluid. Already twelve months before the end of the fixed interest period, old and new building loans can be coordinated so that no forward surcharge and no commitment interest accrue.
In order for a forward loan to be mathematically advantageous, another condition has to be met: the customer really needs the loan after the interest rate has expired.
You need to take out a completed forward loan
A forward loan is a binding loan agreement that both parties must adhere to. This means that if you take out a forward loan, you also have to take it down – even if the interest at the end of the fixed interest rate is lower than that of your forward loan. Otherwise, the bank will charge you a high fee, the so-called non-acceptance fee.
Even if your life situation changes until the end of the fixed interest period, you are therefore bound by the new loan agreement: If you separate from your life partner or move to another city, the new loan can become a problem.
Weigh the pros and cons
Whether the forward loan is a good solution depends on your own life situation, interest rate expectations and interest in financial issues as a whole.
If you expect stability in your environment, you can secure long-term interest rates with a forward loan. On the other hand, if there are changes in the place of residence, employment or use of the property, the borrower risks a financial burden with a forward loan and should rather remain flexible.
Once this has been resolved, a forward loan provides certainty in personal financial planning: the monthly rate for the loan is fixed for years to come, and even a sudden rise in interest rates no longer affects monthly expenditure.
From this point of view, the forward premium is a kind of insurance premium against rising interest rates. Such protection can be sensible and necessary, especially for financing that starts with little equity.
And finally: Many customers do not want to watch the current interest rate environment for years in order to find the best moment for follow-up financing. Then it makes sense to use a low-interest rate level and to regulate the topic for yourself.