Due to the abolition of the tax privilege for mortgage lending, maturing loans no longer play the role as they did a few years ago. Why this is so, and what advantages and disadvantages brings a bullet loan, we explain in this post.
What is a term loan?
In the case of a term loan, the borrower only pays the agreed interest to the bank during the term of the loan. Unlike an annuity loan, the monthly installment does not include repayment. At the end of the term, the loan is repaid in one sum to the bank.
The best example of a term loan offers the interim financing in a home savings contract. The Vausparer pays only the interest to the building society and saves his Bauspar contract. If this is allocated, the building society financing replaces the interim financing.
How do bullet loans work?
The borrower concludes a loan agreement with the bank. The repayment is made by savings contributions in a life insurance, a home savings or other savings contract. This is assigned to the bank. Unlike a repayment loan, the loan amount remains consistently high.
For the bank, this means that it has to expect a total default of the loan over the entire term of the loan. For this reason, the interest rates for a bullet loan are often higher. The interest rate prizes the risk.
The bank pays out the loan, the borrower pays the interest on the loan, which is always the same, and at the same time serves the savings. At the end of the repayment period, he replaces the loan with the capital from the savings contract or life insurance.
While in endowment policies, Vauspar contracts and bank savings contracts, the final capital of the loan amount may correspond, make banks for savings on securities savings. In the case of equity funds, the target final capital should exceed the loan amount by around 30 percent in order to be able to compensate for possible price declines at maturity.
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When does the bullet loan make sense?
Two issues have to be distinguished in this question:
- A timely due savings contract or life insurance should be used for repayment.
- In the case of a property rented externally, the tax-deductible costs, in this case the interest, are to be kept artificially high.
If the borrower still has a life insurance policy for a few years, a term loan makes more sense, even if he owns it himself, because he saves the additional costs for the repayment.
In the case of a third-party rental, the tax aspect plays a role. This becomes all the more important, the higher the tax rate of the landlord fails. With a bullet loan, he uses the tax component for the interest in full over the entire term.
The tax component also works in reverse. Life insurance policies, which were concluded after 31.12.2004, are to be taxed at least in the context of the half-income procedure. However, certain legal requirements must be met.
Otherwise all earned income must be taxed (1). In the case of bank and home savings contracts, withholding tax applies to interest, and to investment funds to total profits, including realized capital gains.
The example calculation
The interest rate on the savings rate was set at four percent pa at the same level as the initial repayment of the annuity loan. The withholding tax was taken into account on the interest income of the savings plan, which increases the savings volume by this amount. If the personal tax rate of the borrower is constantly 30 percent, the net expense is reduced to 37,215 euros.
Obviously, a stock savings plan would be tempting as it generates the highest returns in the long term. However, in this case, a savings rate must be applied, which is higher than average, to finance the buffer mentioned above against possible price losses and the resulting withholding tax.
For a home user, a bullet loan as a financing instrument for a long period of time, even at times of tax-free payment from life insurance, did not count.
The bullet loan with the cover by a life insurance carries a big risk. For a long time, insurers have been unable to keep their rojected performance. The risk of underfunding on the due date of the loan is given if the maturity of the loan amount corresponds to the conclusion of the contract, not the sum insured.
However, this was mostly the case as it made contributions lower. At the beginning of the 2000s, it was sufficient to use 60 per cent of the loan amount as a sum insured for 25 years, a figure from which we have been a long way since the low interest phase.
Early replacement and termination
Definite loans can also be redeemed prematurely, however, it is important to note the following:
- If the fixed interest has been agreed for less than ten years, the bank has a right to the early repayment penalty.
- If the interest rate commitment is more than ten years, the loan can be terminated with six months’ notice to the end of the tenth year.
- If the borrower defaults on his interest payments, the bank can call the loan due, that is, ask for repayment.
- Banks can also terminate loans in the event of a threat of asset deterioration.
For the borrower, of course, it is a rage to terminate the loan early if the savings plan has the necessary balance before reaching the due date. However, it should be taken into account that the prepayment penalty must then be paid. The savings in interest must in any case exceed the costs associated with the termination.
The pros and cons of the bullet loan at a glance
Tail-term loans are one of the few financial products that outweigh the disadvantages even when considered objectively.
- Suitable as interim financing until the allocation of the building society loan
- If a savings contract or a life insurance policy matures in time, in order to avoid double burden by savings rate and repayment.
- Uncertainties in the development of interest rates under the savings plan or insurance.
- Risk of underfunding on maturity of the loan.
- Tax burden on income from the repayment of compensation.
- Over the term higher costs due to the consistently high interest rates.