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Created on 04.03.2024

Construction loans and mortgages: what you need to know

Anyone looking to build, purchase, convert or renovate a residential property in Switzerland can opt for a construction loan or a mortgage to finance it. But what exactly are the differences between these two financing forms? And when should each type of loan be chosen? We have the answers for you.

Anyone who needs external funds to purchase property or for construction, conversion or renovation will normally opt for financing from a lender.

  • The purchase of finished properties can be financed with a mortgage
  • Building projects with ongoing costs (e.g. a conversion, a new construction or a renovation) can be financed with a construction loan

What is a mortgage?

A mortgage is a loan that is secured by a property: if you buy a house or an apartment, you can cover some of the costs with equity and take out a mortgage to cover the rest. Exactly how high this mortgage amount can be depends on factors such as the value of the property as set by the lender.

How does a mortgage work?

In Switzerland, there are three mortgage models: fixed-rate mortgages, variable-rate mortgages and money market mortgages. Fixed-rate mortgages are when borrowers take out a mortgage for a fixed term of one year with a fixed interest rate for this period. Variable-rate mortgages are dynamic and are adapted to the market situation on a regular basis. They are primarily based on the interest paid on the savings balance. Money market mortgages, for their part, are a type of financing where the interest rate is periodically adapted to how the “Saron” reference interest rate is performing (usually on a quarterly basis). Even with a money market mortgage (also known as a “Saron mortgage”), a mortgage term is generally agreed. The same principle applies to all models:

  • Before the mortgage is taken out, the lender will check your credit rating and assess affordability
  • The loan-to-value ratio of the property must not exceed 80 percent of its market value
  • If financing exceeds 66 percent of the market value, the amount in excess must be amortized
  • The costs of the residential property (mortgage interest, amortization, maintenance and running costs) must not account for more than a third of your gross income

What is a construction loan?

A construction loan is a financing solution during the construction phase. A building account is opened for borrowers, and this is used to process running costs for the building project (e.g. for payments to construction companies, manual labourers and architects). The agreed credit facility can be used flexibly. It can also be converted into a mortgage, depending on construction progress. There are two different forms:

Current account credit

Firstly, the borrowers transfer equity to their building account. Bills can then be paid from the building account on an ongoing basis. If the equity is used up, the borrower can apply for credit up to the agreed limit. Interest needs to be paid only on the credit limit actually claimed. Once the construction phase has come to an end, the borrowers pay off the construction loan by converting it into a mortgage. This step is known as consolidation. 

The graphic shows how a current account credit works: the equity paid into a building account (e.g. 500,000 francs) is used to pay invoices for the construction of the property on an ongoing basis. If expenditure exceeds equity, this is where a construction loan comes into play. In this example, it amounts to 700,000 francs. At the end of the construction phase, the borrowers pay off the construction loan by converting it into a mortgage (consolidation).

Partial consolidation

A partial consolidation involves converting a portion of the construction loan into a mortgage before the building project is completed. In addition to partial consolidation, preconsolidation is an option (also known as “forward consolidation”). This involves part of the loan amount being converted into a forward fixed-rate mortgage either before or during the building project.

The graphic shows how a partial consolidation works: in this example, a portion (270,000 francs) of the total construction loan (400,000 francs) is converted into a mortgage before the building project is completed.

How does a construction loan work?

  • All invoices for your building project (construction, conversion or renovation) are settled from your building account on an ongoing basis
  • As part of the construction loan, a construction credit limit is set, and this must not be exceeded during construction
  • An interest rate is payable for the claimed credit limit
  • The affordability rules are the same for the two financing forms
  • The lender monitors all invoices. In particular, the lender checks if the money is actually used on the building project
  • If the building project has been completed, the construction loan is converted into a mortgage (consolidation)
  • It is also possible for the loan to be converted in previously defined tranches (partial consolidation)

Is it worth combining the two financing forms?

Combining these two financing forms may be worthwhile. You generally benefit from more appealing interest rates with mortgages. Early conversion into fixed-rate mortgages makes sense if interest rates increase over the course of the building project. However, with this type of mortgage, you pay interest on the whole sum from the outset, even if you only need the capital later on. With a construction loan, by contrast, you only pay interest on what’s actually claimed.

Your combination options

There are several models for combining these two financing models. You could either have the whole mortgage transferred to the building account when construction begins, or select staggered mortgage payments during the building phase. For example, you can settle predetermined bills from a general contractor through staggered mortgage payments to the building account. This way, you are already in a position to gradually convert your loan before the building project is complete.

Questions and answers

  • A construction loan is a temporary solution: it covers running costs incurred during the construction phase. The process before the loan authorization stage is the same as for a mortgage. The lender checks the credit rating, affordability and the loan-to-value ratio. This way, a credit limit is set that must not be exceeded throughout the building phase.

  • A mortgage is used to finance the purchase of a finished property, whereas a construction loan is used to finance a construction, renovation or conversion project. In the case of the former, you are free to decide what to do with the total loan amount. A construction loan, by contrast, is tied to a specific purpose. The lender checks the payable invoices and will accept and settle only those that are relevant to your specific construction, renovation or conversion project.

  • A construction loan is managed in the form of a current account credit. You can pay invoices on an ongoing basis via your building account. If the equity is used up, you can apply for credit up to the agreed limit and pay interest only on credit actually claimed.

More on the subject

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