You dream of owning your own four walls, but you lack equity capital, which is the prerequisite for favorable financing? In the following article, we will introduce you to an alternative to the classic real estate purchase. You will learn everything you need to know about hire purchase, how this model works and what advantages and disadvantages it entails.
Why is hire purchase an alternative to a property loan?
To apply for real estate financing, you usually have to contribute 10 to 20 percent of the purchase price as equity. For the bank, existing capital reduces the risk; in addition, the ancillary costs are not co-financed and must be paid separately by you. Of course, there are also institutions that fully finance real estate. However, interest rates and requirements are significantly higher for full financing.
Simple understandable principle
With hire purchase, you enter into a rental agreement with the owner. This states that the rented property will become your property at a certain point in time. Furthermore, the purchase price agreed for the house or apartment is specified in writing. The rent includes a precisely defined savings amount for the subsequent purchase. With hire purchase, you move into the property as a tenant and become the owner through the savings amount. When you buy the property, only the amount saved is offset against the price; the previous owner retains part of the monthly payment as rent.
Hire purchase – two models to choose from
You can choose one of the two models described below for this procedure:
Hire purchase in classic form
With this model, you and the current owner determine the conditions under which the property will be transferred to your ownership and when. The purchase price, including interest, is deferred and you pay your debts in monthly instalments. Either the monthly instalments will be so high that you will be the owner after a certain period of time without any final payment. Or you pay the remaining debt with a loan after a rental period. In this case, the sum saved up could serve as security (equity) for the financing bank.
The cooperative model
For houses and apartments owned by cooperatives, the option purchase is often used. You sign a lease that includes an option to buy the residential property. In the event of a purchase, the cooperative deducts a portion of the rent paid from the purchase price. The price is set when you enter into the lease and does not change. You can decline to purchase at the end of the lease because you are under no obligation to purchase. It is also worth knowing that with the classic variant of the hire purchase, it is not uncommon for you to be required to pay 20 percent of the purchase price as a deposit. If you are unable to raise this sum, the down payment is added to the rent in instalments and leads to a significantly higher monthly charge. Since you enter into a binding contract with the owner in the case of a classic hire purchase, you must have the remaining purchase sum available at the agreed time. With hire purchase, a one-off signing fee is always due.
With an option purchase, there is no binding contract, but your option right must be recorded in the land register. In this way, you secure the right to purchase within the specified time. However, this security results in comparatively high rents, which include both repayment and interest. The cooperatives bind their tenants to the purchase with the high monthly charges. Only very few cooperative providers allow terminations and return the savings installments.
Hire purchase always with notarial certification
Similar to the classic purchase of real estate, the transaction at the notary is also obligatory in the case of hire purchase. The effort is even greater because two contracts have to be drawn up. In addition to the rental agreement, an agreement to purchase the property must be drawn up and both documents should be notarised by a notary. Without notarization, any lease-purchase agreement is invalid. In the case of an option purchase, the notary must be commissioned to make an entry in the land register. This right of first refusal expires automatically upon termination of the lease, otherwise it is valid until the fixed date of purchase. Note: Regardless of the preferred option, you should seek advice from an independent real estate expert before making a hire purchase decision. Unfortunately, black sheep in the industry always want to get rid of their hard-to-sell properties via supposedly attractive hire-purchase offers. In the run-up to signing the contract, both parties should consult the notary about possible insolvency and agree on appropriate provisions.
Advantages and disadvantages of hire purchase
Both models have advantages and disadvantages for the owner as well as for the tenant (later owner). The following aspects appear to be advantageous:
- The loan provided by the seller offers easy access to home ownership, but the rent is much higher than traditional rental properties
- Since a loan must be taken up only rarely with the purchase, the banks remain outside with the hire purchase
- Economically, the property immediately becomes the property of the, because he brings in with his rent payments also savings shares
- The agreed instalments are independent of the development of interest rates and remain constant over the entire period.
- The option purchase model allows the tenant to live in the house or apartment for a while and then decide whether or not to buy it.
- The landlord is not bound by the local rent index, he can demand higher rents and does not have to make any repayments if the contract is cancelled
As with every transaction in economic life, there is a downside to hire purchase in addition to the upside. The reverse side of the coin looks like this:
- In the end, you pay significantly more as a tenant than if you were to purchase the property directly.
- Compared with a conventional real estate loan, the conditions are usually worse. The rent is significantly higher than the comparable local rent, and there are also closing fees and other costs.
- In any case, you are required to have an above-average and secure income in order to be able to pay high rents and savings.
- Your payments are usually lost in the event of insolvency of the seller and the planned purchase does not take place.
- The subsidies available for the classic purchase of real estate are not available for hire purchase.
- Although you have to pay proportionately for repairs and modernisation during the rental period, you are often denied any right to a say in major building work
- Experts recommend a repayment ratio of at least 80 percent of the monthly instalment for hire purchase.
Conclusion: Hire purchase as a credit alternative
Hire purchase is often a hastily chosen option for financing one’s own four walls. With the high income required for this, full financing via the bank becomes possible and appears sensible. The somewhat higher interest rates of financing without equity are offset, especially for young families, government grants and subsidies. You should seek competent advice before deciding on a hire purchase and consider the classic route to real estate financing.