The smoothed-payment loan : how to use it (well)?
When a household has a property project, the first concern (and sometimes the main obstacle) will be how to finance it. The necessary cash flow may be lacking, or the debt ratio defined on the basis of existing loans may leave insufficient room for manoeuvre.
The step-by-step loan, or smoothed loan, can therefore be a viable solution for carrying out a project without revolutionising your financial organisation. However, it has certain limitations, which you should be aware of in order to avoid finding yourself in a tricky situation. Let’s take a look at the principle and operation of the tiered loan.
What is the principle of the step loan?
The step-up loan is both simple in principle and complex in its implementation. It is a credit arrangement that proceeds in stages, i.e. the repayment is broken down into variable time periods, during which the applicable monthly payments are different.
The monthly payment may vary several times during the course of the loan, both upwards and downwards, depending on the financial capacity of the borrower and, more often than not, on his or her other outstanding loans.
This type of loan is also known as a ‘smoothed loan’ because the bank is also able to smooth the overall monthly payment so that the borrower, despite the different monthly payments on the various loans, pays the same monthly payment throughout the entire (overall) loan period, thereby ensuring comfortable budgeting.
Why take out such a mortgage?
Several situations may arise, depending on the borrower’s situation. While the aim is always to optimise financing and control the debt ratio, the aim is not always the same.
To be able to acquire a property
The classic user of this type of solution is a property buyer who already has to repay a loan, and whose borrowing capacity is normally insufficient to carry out a new project: he or she can therefore take out a smoothed loan to repay, over the remaining term of the first loan, a lower-than-normal amount of monthly instalments and corresponding to what he or she is entitled to repay in terms of the debt rules.
At the end of the double repayment period (or more), the monthly payments of the smoothed loan may increase to accelerate the resolution of the latter.
Supplementing subsidised loans
First-time buyers in particular, but as a general rule all property purchasers who are eligible for subsidised loans, will often find the tiered loan of interest. Whether they obtain a zero-interest loan (PTZ), an employer loan or a home savings loan (PEL), the stepped loan will allow them to complete the necessary remaining loan, while modulating the monthly payments over time.
At the start of the project, the monthly payment will thus be reduced, with a view to supplementing that of the subsidised loan until the subscriber’s repayment capacity is reached. As the repayment period for subsidised loans is generally shorter than that for conventional property loans, there will come a time when it will be appropriate to increase the monthly payment in order to repay the smoothed loan more quickly.
Reducing the cost of credit
On the same principle of cumulating loans, taking out two bank loans simultaneously with different terms and conditions of repayment is useful to reduce the overall cost of the investment.
The first loan can, for example, be taken out for a period of 10 years, at a favourable rate of 1%. The second loan will be calculated over a longer term of 25 years, at a rate of 1.5%. The smoothing of the loan will then allow for constant monthly payments throughout the duration of the loan, while reducing the cost of interest and loan insurance.
Risks involved and mandatory warnings
In fact, most of the smoothed loans taken out are borrowers who wish to take out a loan that is currently beyond their means, in anticipation of the higher financial capacities expected. The risk is obvious: the financial situation may not improve and the increasing monthly payments may not be met.
The danger is further increased when the lower monthly payments at the beginning of the loan do not cover the interest, which is at its highest during the first years. The result is that the unpaid interest increases the overall capital owed, worsening the debt of the borrower who may not be prepared for it.
It is not so much the bank that is at risk – the loan is still covered by the insurance – as the policyholder who is the first to be put at risk, as he or she is quickly subjected to collection procedures involving various additional costs and ultimately threatened with overindebtedness.
The Court of Cassation (Cass. Civ 1, 25.5.2022, U 21-10.635) thus considers that a step loan, while it provides certain cash flow advantages, also presents dangers of which the subscriber must be fully aware. It is therefore incumbent on credit professionals to provide clear information and to warn their clients against the risk of defaulting on repayment.
This decision requires the credit intermediary to provide a mandatory warning and the lender to provide information, without which they can be held liable.
Who should I contact to take out a smoothed loan?
There are two possibilities. If you are taking out a second (or more) loan, you can contact the institution that granted you the previous loan. In this case, the bank concerned will take care of the arrangement and smoothing internally, according to your request.
There is a difference if you wish to proceed with another bank: the latter will buy back your previous loan, as smoothing can only logically be achieved with a set of loans managed by the same lender. The Lagarde Law then provides a clarification: if some of the loans to be repurchased are consumer loans, they must represent less than 60% of the total repurchase for the property rate to apply. Beyond that, the consumer credit rate will still apply.
Taking out a step-up loan requires a clear vision of one’s financial situation in the long term. Giving in to the temptation of a property purchase, even though it is beyond one’s means, should not be the reason for taking out such a loan, as the hopes of improving income are generally uncertain. On the other hand, a well thought-out arrangement can allow for an intelligent spreading of a debt and even, in certain cases, the realisation of savings.
If you are considering taking out a tiered loan, we strongly encourage you to first contact a professional intermediary lender, who will be able to identify all the parameters of your project and guide you towards the best possible solution.