Financing with a home savings plan

The financing model used by home savings institutions differs from conventional loans, which is why we would like to explain here how it works.

Like all home savings institutions, those based in Luxembourg also charge an arrangement fee. For the two institutions authorised in the Grand Duchy, this fee ranges from 1.0% to 1.6%. In addition, account management fees are charged on the home savings account, ranging from €1.00 to €1.50 per month. As is customary with all home savings institutions, the arrangement and account management fees are included in the loan simulations. These fees are deducted from your payments into the account. The monthly instalments calculated therefore include all fees, meaning that the arrangement and account management fees do not have to be paid separately. These fees are also included in the total loan cost calculations shown in the home savings institutions’ simulations.

The financing models of home savings institutions include a home savings account and are divided into two phases. Different interest rates and instalments may apply to the two phases. In the first phase, the repayment of your loan is paid into the home savings account and not directly against the loan. At the end of the first phase, part of the loan is then repaid using the savings held in the home savings account. As repayment of the loan is deferred throughout the first phase, this loan and the model are also known as a bridging loan repaid through a home savings plan. Because repayment is deferred, the interest does not decrease during the first phase. Interest accrues on the full loan amount for the entire duration of the first phase. That is the biggest drawback of this model. If the interest rate on the bridging loan is the same as on a conventional loan, then the bridging loan will cost more. However, the bridging loan with a home savings account can be cheaper than a conventional loan if the home savings institution’s rate is below the average market rate. Since home savings institutions do not always adjust their rates as quickly as traditional banks, this has happened several times in the past. In 2020, for instance, one home savings institution was offering a nominal rate of 0.49% over 10 years in its tariff.

The second phase is a traditional loan, where repayments go directly against the loan and the interest decreases with each payment.

When comparing a home savings institution’s loan with conventional loans from other banks, it is important to consider what happens once the initial fixed-rate period expires. What is the effect if market rates rise? What are the repayments and the cost of a traditional loan compared with a home savings institution’s loan? If the rate is fixed for the entire duration of the first phase, there is no risk in the home savings model. The rates are fixed for the whole term and all the payments are known from the start of the contract. If, however, the initial rate is fixed for a shorter period than the duration of the first phase, the rate will be reviewed once the fixed-rate period expires and you will receive an offer from the home savings institution for a new rate. In every case, you have a fixed rate for the second phase of the financing. As the rate for the second phase is set when the contract is signed, the risk of a rate increase on a home savings institution’s loan is markedly lower than on a conventional loan.

Example:

Suppose the loan term is 30 years and that the first and second phases of the home savings institution’s loan each last 15 years. Suppose too that, on both the home savings loan and the conventional loan, the rate is fixed for the first 10 years. On the conventional loan, after the 10th year there is a risk of a rate increase for the final 20 years. On the home savings loan, by contrast, there is a risk of a rate increase for only five years, namely from the 11th to the 15th year, since the rate is fixed for the last 15 years.

If you make an early repayment on a loan while the rate is fixed, the bank may require what is known as an early repayment charge. This applies to traditional banks and home savings institutions alike. However, the law of 23 December 2016 limits this charge to six months’ interest where the property financed with the loan is the main residence and the borrower has lived there for at least two years. That restriction applies only up to a maximum repayment of €450,000. Above €450,000, the bank may charge its actual loss, however large. Unlike other banks, one of the home savings institutions authorised in Luxembourg applies the capped charge of six months’ interest to the entire loan amount. That is a clear advantage over the other banks, which apply the statutory €450,000 ceiling to this charge and bill their actual loss above that amount.

Home savings institutions also offer other early repayment options that provide more flexibility than conventional loans. As repayments during the first phase of a home savings loan are not credited directly against the loan but to the home savings account, you can make additional payments into the home savings account during the first phase. Such a repayment therefore carries no charge, and it also shortens the term of the loan and hence the total cost of the credit. These repayments are, however, generally limited to a maximum of five per cent of the loan amount per year. In the second phase, on the other hand, all home savings institutions allow early repayments of any amount, up to the full loan amount, without any charge.

In short, the home savings model offers the security of a fixed rate combined with markedly greater flexibility in the event of early repayment. That combination does not exist with conventional loans. With those, you have to choose between a fixed rate, with no risk and no flexibility, or a variable rate, where you have more flexibility but also the risk of rate increases.

Finally, when comparing rates and costs between the two models, you should also take into account the larger tax deductions available on a home savings loan, since you can deduct part of the repayment in addition to the interest. As the loan is repaid via the home savings account, you can declare not only the loan but also the home savings contract in your tax return. Since the tax refund can be higher than with a conventional loan, the real cost of this model can also be lower than the cost shown in the loan calculation. Since the 2017 tax reform, however, the funds in the home savings contract must be used for the main residence. For that reason, the home savings contract linked to the loan should only be used for tax deduction purposes where the property financed with it has not been let.