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.
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.
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:
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:
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.
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.
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.
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.
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.
