Construction loan 

When you have acquired a land to build your property, whether it is done through a contractor or an architect, or when you want to do important renovation work, you will need a construction loan (in french, “Crédit de construction”), which slightly differ from a mortgage loan. This article will explain the different options at your disposal.

Basics of the construction loan

Before approving the requested loan, banks will make sure that your finances are in line with the requested loan amount (as it is done for mortgage loan approval), but they will also check the finances of the contractor or the architect, to limit any risks. Should either of them go bankrupt during the construction, the buyer could legally be responsible for it through what is called in Switzerland «Hypohtèques légales » (literally, « Legal mortgages »).

Banks will open a specific account under the name of the contractor or the architect (called « compte miroir »), in order to make sure that the money is used to pay for the construction. They will also follow closely the progress of the construction. For these reasons, construction loans are only approved by banks (insurance companies and pension funds do not want to bother with this extra amount of work).

Types of construction loans

The classical construction loan

The first bills will be paid through your down payment, and then through the approved loan.

As bills add up, the loan increase, therefore the interest will as well.

Advantage :

• You could choose a bank to do the construction loan only, and once the construction is done, switch (consolider) your loan to another mortgage provider (banks, insurance companies or pension funds)

Disadvantages :

• Because of the heavier work load a construction loan requires, banks dont prefer to be used soley for the construction, and therefore will generally charge fees if you choose to switch (consolider) to another mortgage provider
• Interest rates for classical construction loans are high (between 2.5% to 3.5% during the construction)
• Interests paid on a construction loan are not tax deductible (contrary to mortgage loans)
• Banks cannot guarantee what the the mortgage rates will be at the end of the construction project

« Switch while in progress » construction loan (Consolidations partielles)

The start of the loan is exactly the same as in a classical construction loan structure. However, in this case, you will be able to switch (consolider) your construction loan to a fixed mortgage through « tranches », while the construction is in progress.

For example, after the first CHF 200k have been used from the loan to pay the ongoing bills, you could decide to switch (consolider) the CHF 200k into a fixed 10 years mortgage loan. A few months later, when another CHF 100k has been used, you could choose to do the same.

Advantage :

• As soon as you switch (consolider) your construction loan to a mortgage loan, the interest for that specific « tranche » will be lower, since the rate on a fixed mortgage is lower than the one applied to a construction loan

Disadvantages :

• Before switching (consolider), the bank will apply the construction loan interest rate to your case (2.5% to 3.5%)
• After having switch your first « tranche» from a construction loan to a fixed mortgage, you will not have any other choice but to switch (consolider) the remaining of the loan with the same bank, making this option not very flexible
• Banks cannot guarantee what the mortgage rates will be during the construction project

« 2 in 1 » construction loan

With that scenario, the construction loan is actually a fixed mortgage loan. You will choose from the get-go the lenght of the contract (from 2 to 10 years), and therefore will know right away the interest  you will pay on your loan throughout the construction, and once you have moved in into the property. The interest rates applied to your case will be very similar to the ones applied to a fixed mortgage.

Advantages :

• The interest rates will be similar to the ones applied on fixed mortgage, thus lower than construction loan rates
• No need to worry about the mortgage market rates at the end of the construction, since you will not switch (consolider) your construction loan to a fixed mortgage

Disadvantages :

• Only a few banks offer the «2 in 1» option (although it is our preferred choice)

Article related to this subject : the closing costs.