construction loan construction financing for your dream home

Use a construction loan to build your dream home

Many people dream about building an owner-occupied home. However, before construction can begin, you have to answer the question of how to finance the construction. In most cases, the answer lies in a construction loan from a bank. Construction loans offer a high degree of flexibility and a clear overview of all costs for building a home on credit.

A construction loan is different to a mortgage

Living within one's own four walls – This is a dream that many people would like to realize at some point in their lives. Perhaps a purchased home cannot fulfill all your individual requirements. If you don't want to compromise, you can decide to build a new home or to undertake extensive renovations. That costs a pretty penny, however, and is often impossible to finance without borrowed capital.

The solution? A construction loan. Unlike a mortgage, the sum that is paid out is not fixed. The builder-owner merely agrees with the bank on a maximum credit line for a special account that is used to cover the ongoing costs of building the house. Because the credit must ensure financing for the entire property, it is important for the builder – together with the bank – to create careful and detailed calculations in advance. A credit line that can be flexibly used to pay bills on an ongoing basis is ideal.

Special features of a construction loan

While a mortgage is normally used to finance a finished property, a construction loan covers invoices for construction or renovation work. This has the following advantages:

  • Flexible payment options are possible in connection with the financing of the construction project.
  • The construction loan is managed in the form of a current account credit.
  • The construction loan has a variable interest rate based on the individual offer.

How much equity do you need for a construction loan?

At least 20% of the property's total value must be raised as equity capital and the amount must be paid into the construction account before any work on the property begins. After all, it's not possible to finance the building of the property without your own equity capital. This amount is used to pay all invoices incurred at the beginning. The construction loan is used only after the equity capital has been completely exhausted. This can be used up to the credit limit agreed with the bank.

Unlike a mortgage, the loan amount is not fixed. Instead, it is flexible. This is the main advantage of construction financing. The bank charges interest only on the amount that has already been taken as credit. In return, the interest rate charged is higher. In addition, a commission fee is charged.

Construction loans are earmarked

The capital from a construction loan is not freely available. It is earmarked for the entire term of the financing. The money may only be used to pay the costs incurred for the construction, conversion, or renovation of the property. To ensure this, the bank itself processes the payments made via the construction account. All other types of invoices will be rejected.

The builder-owner does not have access to the account. They must send the bank all of the invoices they receive from craftspeople and architects for work on the house. These invoices also include the costs for building materials. This procedure also offers advantages for the builder-owner: It eases the administrative burden on them and simplifies cost control. This is important because it is difficult to consider all the costs of a new construction, even with the best planning.

The construction loan is consolidated once construction is complete

You no longer need a construction loan once the house is finished. Consolidation is now possible. Typically, after construction is finished, the bank converts the entire loan into a mortgage, at your choice. The mortgage is subject to the regular rate of interest and must be repaid if the equity capital paid in is less than one-third of the total amount.

However, full consolidation at the end of the construction phase is not the only available option. If the interest rate for the construction financing is considerably higher than the mortgage interest rate, a partial consolidation before construction is completed may be financially worthwhile. However, the mortgage may not be higher than the amount of the construction loan that has been claimed up to that point. It's worth discussing this type of financial considerations with the bank.

Finally, there's also the option of consolidation on a fixed date. This option is also known as pre-consolidation. In this case, a Forward fix mortgage is taken out for part or all of the loan amount before or at the time when construction work starts.

How construction financing works using a construction loan and full consolidation

How construction financing works using a construction loan and full consolidation

In the initial phase of construction, the equity capital must be used up first. Only then do you take advantage of the actual construction loan. Once construction is completed, the loan debt is converted into a mortgage.

Source: Credit Suisse

Find the right construction financing

Each new build or renovation is unique and has different financing requirements. It may be worthwhile to compare various construction financing solutions. There may be stark differences in interest rates, the maximum term, the minimum amount, and the construction project requirements. You should think carefully before making a a financing decision. It lays the foundation for the entire project. With the optimal solution, your dream of home ownership will soon be within reach.

Are you interested in a construction loan?

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