Building savings for the future: with this title, some may have thought to themselves: What else for? For the past? There is a model in which you take out a building savings contract now for a property you want to buy now. This is the topic of part 3 of this series. For now, however, let's talk about classic building savings for the future: I am taking out a contract now, and in a few years I would like to buy or build first.
For those who have never looked into home savings, Part 1 of this series provides basic information on how home savings works.
Building savings for pure saving
Who concludes a building society contract, is not obligated to take the loan afterwards. It is therefore also possible to conclude a building savings contract for pure savings without the intention of ever taking out a loan. The fact that this can not be useful in principle, quickly becomes clear when you consider what "the deal" is with building savings is: lower interest in the saving phase (= disadvantage) for lower interest in the loan phase (= advantage), as explained in part 1.
So why take a disadvantage in saving if you do not plan to take the advantage in the loan. This also becomes very clear when you look at the current conditions: 0.1% interest on credit balances. There are many daily money offers 1 , which are clearly better. And the fees for a call account- if you really want to pay some- are significantly smaller than 1% of the savings amount. This is what is due in any case with a building savings contract.
In short: building savings contracts to save without the (firm) intention to build or buy later is not a good idea.
Building savings for the future property
So what about building savings for the future property? At least in principle there is nothing against it, because this is the classical idea of a building savings contract. But is it therefore also good? To find out, let's make a comparison: building savings versus saving on the stock market in combination with an annuity loan. On the one hand we consider the classic building savings with subsequent building savings loan and on the other hand we save with market wide index funds to then take out a regular annuity loan for the missing sum. The expectation is that we will increase our money faster in the stock market than in the savings phase of the building society contract. On the other hand, the interest rates for the annuity loan will probably be higher. So the interesting question is: what would the interest rate on the annuity loan have to be in order for home savings and index savings to come out equally well. If the interest rate is higher, the saver is happy; if it is lower, the index saver is the winner. So we want to determine a marginal interest rate.
A fair comparison
So that we do not compare the famous apples and pears with each other, we must ensure with some criteria that the comparison becomes fair:
- Same amount to be financed
- Same term for savings and loan phase in both cases
- Same monthly savings rate
- Same monthly loan installment
- Consideration of all respective costs and fees.
For a really fair comparison, we would also have to include the respective risk, but more about that later in the conclusion.
The data for building savings are relatively simple, since here everything is predetermined. So we do not have to make assumptions for the future. However, we must of course choose a bauspar tariff. In the following, I use a tariff for which I have a fully calculated offer. Whether it's the best rate, of course, I can't say, but the rate is definitely competitive. With a savings period of 15 years, the tariff is certainly not the typical home savings tariff, but allows us to make a fair comparison with the stock market. For with a savings period of only seven years, index saving would certainly be bold. So now the hard facts:
- Tariff: LBS Long Term Plus
- 117.000€ Building savings 2
- 1% closing fee, i.e. 1.170€ due at the conclusion of the contract
- 9€ Per year fees (will be deducted from payments)
- 265€ / month savings rate
- 0,1% interest on credit balance
- After 15 years the savings balance is: 47.918,89€ incl. 356,14€ Interest and 137,25€ ongoing charges.
- 69.081,11€ Loan (= 117.000€ – 47918,89€)
- 2.35% debit interest
- Monthly rate 468€
- Repayment in 14 years and 7 months. That's fast, so the lower interest rate matters less than perhaps intuitively assumed. 3
- Total interest payments: 12.533,23€
For index saving, we can't get around one important assumption: the average (geometric) return per year. Let's go with 7% here, that seems fair. The remaining data must be adjusted so that the comparison is fair. The indication of the amounts in the following on cent exactly is of course completely exaggerated in the context of the accuracy of our assumptions. I have nevertheless written down the cent amounts, in case someone wants to do the math. Then it is exactly clear: this is the same result or not.
- Savings phase
- Initial balance 1.170€. Herewith we compensate the acquisition fee of the building society contract again.
- Monthly savings rate 265€. Thus the monthly burden is the same.
- 7% yield p.a.
- Final withholding tax is taken into account.
- No more fees. Since further fees can be avoided with a savings plan, no further fees are considered at this point.
- This results after 15 years 74.128,48€. These are 26.209,59€ more than the result of the bauspar up to here.
- Required loan: 117.000€ – 74.128,48€ = 42.871,52€
- Instead of 60% as in the case of building savings, only approx. 37% of the total amount needed as a loan.
The interesting question now is how high the interest rates have to be for both to perform equally well. The only way for a fair comparison is to choose the same rate for the loan, so also 468€ per month for the same term (14 years and 7 months). That this is fair can be seen by the fact that both "spent" the same amount of money per month for the same amount of time and in the end both would have a value of 117.000€ own. Intermediate results no longer play a role.
Note: To compare only the cost of the two loans, that is, the 12.533.23 for the bauspar case, would not make sense, as this would result in different maturities. In addition, the loans are different.
A comparison with the same duration shows that the marginal interest rate is 10.06%.
Just for saving, building savings contracts are definitely not suitable.
Who wants a loan and assumes that the interest rate in 15 years is over 10%, should go to the building savings contract. Everyone else would probably be better served with index saving and a normal annuity loan.
It is- at least for me- fascinating how much the naive idea "if the interest rate is above 2.35% (the target interest rate) I will benefit from building savings" is wrong. It would be more correct to say that if interest rates are above 10% in 15 years, people will benefit from building savings. This is a stark difference. The reason for this is the large difference in the interest rate on credit balances.
Does it always apply?
The large difference between credit interest on building savings and stock market yields is of course due to the current zero interest rate policy. If one would get 3% to 4% credit interest for a bauspar contract, the gap would be much smaller. However, the debit interest would then of course be much higher, so you would have to look at a completely different rate. Such a consideration would certainly be interesting, but that would be a different article: "Did Bausparen for the future earlier worthwhile?“
At least for the current situation we can say: saving for the future is probably not worth it.
Final word on the risk
At first sight, the comparison may seem very fair. However, one should also consider the risk. We have pretended here that the stock market return is as safe as the building society loan interest rate. This is of course nonsense. So in principle it should not be surprising that the significantly riskier index savings in the long-term expectation 4 better than the very low-risk building savings. Due to the relatively high marginal interest rate of 10%, there is still some room for maneuver if the stock market does not perform as well as planned.
Those who generally do not like the stock market and therefore choose the building savings option should perhaps also think one step further: building savings is certainly very low-risk. But what you plan to do with the money afterwards is anything but low-risk: investments in real estate are- although often not felt- at least as risky as index savings. Maybe even more risky.
Are bauspar contracts crap?
So far we have seen that building savings contracts in the current situation are not so good for saving for the future. But maybe they are better suited for long-term interest rate lock-in? This is the topic of part 3 of this article series. If you want to have another look at the basics of building savings contracts, you can have a look at part 1 here.
Update 13.03.17: Stefan (real estate investor) points out another interesting point in the comments: Building savings contracts can be used to "leverage equity". The idea is that one saves 40% and then the 100% (so incl. of the building society loan) into a financing as equity capital. This can significantly improve the conditions for the rest of the loan. As good as "real equity but this will probably not work.