1 percent redemption: not the best choice for investors

When financing investment properties, an initial repayment of just one percent is very often agreed. This is common in Germany, many bank and tax consultants recommend such as a low initial repayment.

The justification is always the same: the duration of the financing (and thus also the amortization) is of little importance, after all, the interest can be deducted from the tax.

The interest can be deducted from the tax

The interest can be deducted from the tax

The purpose of this paper is to clear up the prejudice that higher repayments are not worthwhile. On the contrary, investors who purposely repay more are better off in the long run. There are two reasons for this

  • faster debt-free (means more security)

  • higher return

The first point is explained quickly. If the property loan is fully repaid, there is no more financial pressure. Assuming the rental income is off, this is half as bad. The remaining costs are usually easy to carry.

An improvement in the return is like doubts. No wonder, after all, it is tempting to claim the interest costs for tax purposes. At the same time, it seems to make little sense to tax the rental income in full. But a look at the naked numbers provides clarity. The following example is intended to illustrate why a quick and thus increased eradication is more profitable.

example

The monthly rental income is 500 euros. The investor is a top earner, his tax rate is 50 percent.

Variant 1: rental yield with loan

The investor pays a monthly loan, which is 350 euros. The interest portion of the monthly rate is 250 euros. The following calculation refers to one year.

Total rental income (500 * 12): 6,000 euros

Total interest (250 * 12): 3,000 euros

taxable rental income (6,000 – 3,000): 3,000 euros

Tax burden (3,000 * 0.5): 1,500 euros

Total loan installments (350 * 12): 4,200 euros

Sum of the installments: 4,200 euros

Profit before tax (6,000 – 4,200): 1,800 euros

Profit after tax (1,800 – 1,500): 300 euros

Variant 2: rental yield without taxes

Total rental income (500 * 12): 6,000 euros

Total interest: 0 Euro

taxable rental income (6,000 – 0): 6,000 euros

Tax burden (6,000 * 0.5): 3000 euros

Profit after tax (6,000 – 3,000): 3,000 euros

Interpretation of the example calculation

cash

In the second variant, it is nice to see how much the loss of interest rates will have on the tax burden. Instead of 1,500 euros, the treasury cuts a total of 3,000 euros. This may sound bad, but the bottom line is the profit for the real estate investor is much higher, it remains ten times the amount!

Of course, the example calculation is constructed – but only so that it is easier to understand. In the end, however, it does not matter what numbers are used. The investor, who repays his loans quickly, pays more taxes, but also makes more profit. Especially in the long run, this effect is extremely noticeable.

Anyone who is still critical should consider one thing: it’s great to have the chance to save taxes. But in the end, it’s not about tax savings, but about the money that ends up in your own pocket. Especially in the example of a tax rate of 50 percent was assumed. Many investors have a lower tax rate, which even improves their return if the residual debt on their loan drops rapidly.

Criticism of the quick eradication

Criticism of the quick eradication

The main criticism of the concept of increased eradication is the financial pressure. Should the rental income fail to materialize, the bank rate becomes a threat more quickly. Fortunately, it is possible to hedge against this risk. So it would be conceivable, for example, to agree only on an initial repayment of one percent.

Unless extraordinary events occur during the year, a special repayment will be made. This way, the investor stays flexible and can repay his loan quickly.

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