Construction loan optimisation

Author : Kristen

Construction loan optimisation

For the buyer, construction financing often begins with a seemingly harmless construction loan. Nevertheless, the quarterly commission of such a loan is often neglected and becomes a sore spot down the road. At most banks, the quarterly commission of a construction loan is up to 0.25% (calculated on the highest debit balance or an average loan). Considering that the average construction period is 12 months, this commission makes up a cost of 1% that is added to the base rate. This commission covers the administrative costs associated with the construction work supervision (monitoring how funds are allocated by trade, invoice payments, site inspections, etc.) In the example of a base rate of 2.50% + 0.25% in quarterly commission, the final rate obtainable for one year amouts to 3.5%. Keep in mind that the construction loan interest is not tax deductible.

An alternative would be to choose a bank that does not charge quarterly commission. Otherwise, it is more in your interest to negotiate the commission than the rate itself. Even still, you should be cautious because certain institutions offer advantageous conditions to attract the client in the beginning, but then they charge the difference of the granted privilege if the consolidation is carried out somewhere else.

In any case, the choice to take out a construction loan carries significant future consequences, sometimes without you knowing it. The time needed tp complete a house, an off-plan apartment, or a building will range between 6 and 8 months. From the moment the shovel breaks ground, it is already too late to make any major changes to the financial plan. For this reason, it is essential to prepare your financial strategy well in advance and to choose the best mortgage loan.

The development of interest rates remains a major risk during the construction period.

Unlike the construction loan, the mortgage loan will last for a number of years. Of course, it is possible to save on a construction loan, but considering its short duration, is it really the best way to save money?

For better understanding, let's return to the topic of construction loan consolidation. This is the conversion of the construction loan into a mortgage. The moment of this conversion does not necessarily have to fall on the move-in date, but rather when all of the administrative tasks required by the financial institution are possible (statement of work completion, final construction settlement, confirmation of no statutory mortgage, etc.) Normally, this conversion is straightforward and uncomplicated. However, there is still a risk that it could turn into a real ordeal: a delay in construction, administrative obstables, finishing work that has to be redone, undersestimated deadlines, etc. All of these factors could lead to delays.

In order to avoid such trouble, many buyers choose to reserve fixed rates beforehand, even before the real estate property is delivered. This is also known as a "forward." As an indication, the cost of forward rate reservation is somewhere between 0.10% and 0.50% one year before the rate starts to be effective. Thus, the client will pay this surcharge throughout the entire validity period of the rate. Reserving a rate on a "forward" basis makes it possible to predict a substantial increase in the fixed rates until the delivery of the real estate property (assuming risk if the rates go down). The forwarded rate will not be adjusted when the loan is consolidated, except for the penalty.

The starting date of the mortgage loan with forward rates should coincide with the completion date of construction work as stated by the builder. What happens in the case of major delay? Here are few different consequences:

1. The mortgage and construction financing are ensured by the same bank

Consequences are almost non-existent. In fact, given that the bank itself has a supervisory role, it decides how the funds are used. Even with a fixed rate reserved in advance, it will still be possible to repay the construction loan automatically. Since not all of the invoices have been paid at this point, the mortgage loan surplus is disbursed to the construction account, which is then used on a creditor basis. The only drawback will be the interest to be paid on the overall mortgage loan. However, such costs are calculated on the amount used for the construction loan.

2. The constuction loan is consolidated by a third-party institution

When reserving the fixed rate, a date for resuming financing is also fixed. On this date, the financing becomes available to the client. If the construction loan cannot be repaid (for example, in the event of administrative problems already mentioned), a double "rent" is started. This means that you will have to continue paying interim interest (interest on construction loan) as well as the interest on the mortgage loan charged by the second institution. This double cost will last until all of the necessary elements for organising the resumption of the construction loan are in place.

In case of delay, you have other options to proceed. In this case, it is essential that you pay attention to the provisions of the loan agreement that apply to a potential delay and the submission of related documents. It is also possible that the rate will be raised 0.1% per month of delay (and spread across the entire duration of the fixed rate). It is also possible that the financial institution will simply terminate the loan and require a break penalty that could amount to several dozen thousand francs. This is why you will have to give yourself a sufficient manoeuvre margin or 2 to 3 months between the expected delivery date and the actual consolidation.

To simplify the process and reduce risks, we recommend that you consolidate your construction loan with the same institution. Paradoxically, it is often noted that the institution offering good construction loan terms does not necessarily offer the best terms for a future mortgage loan. For the same reasons, it is now well known that insurance companies offer excellent rates, but they do not give construction loans.

Another option is to proceed with partial consolidations. As a matter of fact, from the moment when the used of a construction loan goes beyond a certain amount (between CHF 100,000 and CHF 200,000, depending on the institution), it is possible to convert part of the construction loan into a fixed-rate mortgage loan. Thus, the agreed rate begins immediately. The primary advantages are avoiding the cost of the forward fee and quickly stabilising a part of the financing. From this moment on, the client is bound to the institution for the rest of the financing and the consolidation balance (rate discount, debreciation, collateral, etc.) should therefore be negotiated in advance in order to avoid any unpleasant surprises.