Construction loan: definition

A construction loan is a specific form of property financing used to pay, step by step, for construction, conversion or renovation works on a property.

The term “construction loan” refers to credit made available through a temporary current account: the account is debited progressively as invoices arrive (contractors, architect, tradespeople), and you only pay interest on the amounts actually used. In the context of a Swiss mortgage, the construction loan generally groups the 1st and 2nd ranks under a single rate during the construction phase, before being converted, at the end of the works, into a “standard” mortgage (fixed-rate mortgage, SARON variable, mixed).

How a construction loan works during the build

To understand the idea of a construction loan, picture a current account dedicated to your building project:

• Setting up a construction account
The bank opens a construction loan account and makes available the maximum amount planned for the project (for example CHF 800,000). This construction loan can finance both the build of a house and major conversion works; it may also be referred to as a renovation loan.

• Releasing funds as invoices come in
The account is debited only when invoices arrive: invoices from contractors, the architect, engineers, tradespeople, etc. Often, payment requests are signed by the site manager and/or the architect, then sent to the bank. The bank pays the invoices directly from the construction loan, in line with progress on site. Result: the loan is only drawn as the works are actually carried out.

• Interim interest calculated as accurately as possible
Interest on the construction loan – often referred to as interim interest – is calculated only on the amount already drawn. If, at the start of the project, only CHF 200,000 has been released, you pay interest on CHF 200,000, not on the total amount planned. With each new invoice payment, the drawn balance increases and the interest is adjusted. You therefore only pay for works already completed.

• Grouping 1st and 2nd ranks, single rate
During the construction phase, the construction loan covers the entire financing (portion equivalent to the 1st and 2nd ranks) at one single interest rate. This simplifies management: you have one account, one rate and a global view of incoming flows (equity paid in) and outgoing flows (payments financed by the bank).

• Tracking and transparency
The bank keeps a detailed statement of all invoices paid, amounts financed by the construction loan and contributions made from your equity. You therefore have a clear overview of how your down payment and borrowed capital are used. This makes it possible to check that payments match progress on site and that the project’s overall budget remains under control.

From a construction loan to a mortgage: consolidation

When construction, conversion or the renovation loan comes to an end (building completed, handover of the keys, renovation works finished), the construction loan is converted into a standard mortgage. This is known as consolidation:

The bank calculates the final amount drawn on the construction loan (for example CHF 780,000).
Interim interest due during the construction phase is integrated or settled according to the agreed terms.
The balance of the construction loan is converted into one or more “standard” mortgages (hypothèque fixed, SARON variable, mixed), potentially split between 1st and 2nd ranks.

After this consolidation, the construction loan ends and you move into the “normal” financing phase: you pay mortgage interest and, where applicable, direct or indirect amortisation on the mortgage.

Concrete example of a construction loan for a single-family home

You build a house in Switzerland with a total cost of CHF 1,200,000, including CHF 300,000 in equity and CHF 900,000 in bank financing. The bank sets up a construction loan of CHF 900,000.

Start of the works

Foundations, structural work, first advance payments to contractors: the bank pays, upon receipt of signed invoices, a total of CHF 250,000.
The amount drawn on the construction loan is therefore CHF 250,000.
You pay interim interest only on these CHF 250,000.

Midway through the works

Work progresses: masonry, roof, windows, technical installations.
New invoices for CHF 350,000 are paid via the construction loan.
The amount drawn rises to CHF 600,000; interim interest is recalculated on this new amount.

End of the works

Finishing works, kitchen, sanitary fittings, outdoor works: a further CHF 300,000 of invoices are paid by the bank.
In the end, CHF 900,000 has been drawn on the construction loan.

When the house is completed, the construction loan is consolidated:

The CHF 900,000 is converted into mortgages (for example CHF 650,000 in 1st rank and CHF 250,000 in 2nd rank).
You choose the split between a fixed-rate mortgage, a SARON mortgage or a mixed mortgage.
Interim interest paid during the construction phase is taken into account in the overall calculation of your financing.