Construction Financing: Types, Possibilities and Suitability for Building Owners
Every real estate acquisition or house construction is associated with its own challenges. Rarely is it possible for people to finance real estate from their own capital, which is why the question of construction financing arises. Especially for high-priced premium properties in top locations in cities like Düsseldorf or Paris, a real estate loan or other form of financing becomes due. The financing options range from the classic annuity loan and the full repayment loan to the building savings contract and hybrid forms such as the building savings combination loan.
All these possibilities serve you as a future homeowner as a financing basis for realizing your plans. Therefore, the question arises as to which of the financing forms is the most suitable solution for which project. Knowledge of how the financing types work and the conditions of the financing types is an important prerequisite for a well thought-out decision between a real estate loan, a building savings contract or a hybrid form.
Annuity loans (classic bank loan)
The term annuity loan is one of the most commonly used methods of mortgage financing. It is a classic bank loan, which is used particularly often in housing construction or property acquisition. A characteristic feature of this type of financing is the ongoing repayment of the loan. The loan is therefore to be repaid by you as the borrower in fixed, constant amounts (annuities). This gives you as a borrower a certain degree of planning security over the entire course of the construction financing.
The annuity of the loan is essentially made up of the repayment amount to be agreed from the beginning as well as the interest portion. The respective repayment amounts are calculated periodically. For this reason, the interest on the remaining loan decreases.
This benefits you as a builder-owner: the loan installment remains constant, while the redemption portion increases constantly. The interest portion thus decreases over time. As a borrower, you can follow the rule of thumb that the faster you repay the real estate loan, the cheaper the construction financing.
With a conventional annuity loan, a residual debt typically remains when the fixed interest rate expires. This requires follow-up financing. Follow-up financing is due wherever the loan has not yet been fully repaid when the real estate loan expires. In the case of long credit periods with a time horizon of several decades, it is rarely clear in advance whether and under what circumstances or under what conditions follow-up financing is even possible. An alternative is the full repayment loan.
Full repayment loan: No residual debt at maturity
The full repayment loan represents a special variant of the annuity loan in construction financing. A characteristic feature of this type of real estate loan is that at the end of the agreed loan term, you no longer have any residual debt. A typical characteristic is the conclusion of the loan with a comparatively long fixed interest period. Here too, the loan instalment must be fixed at the beginning of the loan and remains unchanged in the further course of the loan.
As a borrower with this form of construction financing you always benefit from a special right of termination after ten years of fixed interest. It is therefore also possible to reschedule the full repayment loan under these circumstances.
There is only one phase of fixed interest rate in the case of a full repayment loan. At the end of this phase, the loan amount is usually repaid. You therefore waive the need for follow-up financing. The loan installment calculated in advance and the repayment to be determined in advance enable you to plan with a high degree of security as a borrower. It is also the rule that lenders grant a certain interest discount when concluding a full repayment loan agreement.
One advantage of a full repayment loan is the possibility of paying off a construction or real estate project in full within a manageable period of time. Frequent terms of this type of loan are between 10 and 20 years. It is possible to shorten the term, as you typically pay significantly higher redemption amounts than with a regular annuity loan.
Construction financing with building savings contract
Another method of mortgage lending that is used very often is the building loan agreement. With building society savings, you as a building society saver conclude a contract with a contractual partner (for example, a building society) over three phases: the savings phase, the allocation phase and the repayment phase. As a building society saver, you pay into a building loan contract during the savings phase. This deposit is made in monthly installments that are set in advance. The aim of the savings phase is to achieve an equally defined savings amount. This is followed by the allocation phase. Here, on the one hand, the savings amount saved is paid out and, on the other hand, it is topped up with (particularly low-interest) loans, so that you have capital to finance the real estate project. Following the financing of the desired property, the repayment phase follows. Here you pay back the loan amounts to the building society in monthly installments.
With a home loan and savings contract, you can either use the real estate project in the classic way or combine it with a repayment-free advance loan. A home loan and savings contract is a suitable instrument for securing interest rates. In a suitable combination with an annuity loan, the future residual debt is protected from interest rate increases.
In the case of a home loan and savings contract, it must be taken into account that the allocation date can never be certain. Building societies may not guarantee or guarantee you as a customer such a time. A connection fee is also to be expected.
Combined financing: Combined home loan and savings loans
As a combination of a home loan and savings contract and real estate loan, combined loans offer a financing alternative for purchasing real estate. Building societies offer this option as a way of pre-financing the later disbursement from the building society contract. It is therefore a combination with an amortization-free loan or advance loan and the actual home loan and savings contract.
The main difference to the classic bank loan is the different repayment concept. Only the interest has to be paid for the advance loan combined with the home loan and savings contract. As a building society saver, you transfer the respective savings installments to the building society contract instead of the repayment. If the home loan amount is finally allocated (for example after ten years), you use it to replace the advance loan. Typically, the components of the home loan and savings combination loan are coordinated in such a way that both the installments and the interest are fixed over the entire term of the contract.
When the home loan and savings agreement is ready for allocation, the full home loan amount is paid out to the bank that granted you the loan. This completely replaces the advance loan and you, as the borrower, only have to pay back the building society loan including the accruing interest in monthly installments to your building society. Usually, the building society loan is 60 percent of the building society’s sum. There is therefore a time advantage compared to the regular building society contract.
It should be taken into account that in practice you will pay interest twice for this time saving, which practically relates to the same capital and extends over a longer period. First, you pay the interest on the advance loan (during the savings phase of the building society loan agreement). You then pay interest again on the building society loan, i.e. on 60 percent of the sum of the advance loan.
To choose the appropriate form of financing
The right form of financing is the result of your personal ideas and the requirements of the real estate project. The right form of loan or other form of financing is the result of a close examination of the financing challenges as well as your interests and means.
Buyers and developers will find the right model for your project for almost all financing needs. In order that you can reduce the types of financing to a smaller circle, you must first determine what form of financing the property is to be.
If you are financing a property for the first time or already own a property and are planning a further purchase, refinancing is necessary. If you have already started to finance a property and the fixed interest period is coming to an end soon. Then a follow-up financing of the property becomes relevant. It is also possible that you are planning to purchase a property using equity capital (which is released from the sale of another property, for example). The equity capital may not be available to you at the moment. In this case, interim financing is advisable.
The choice of the type of financing depends not only on personal circumstances, but also on interest rates and conditions. Many experts consider building society contracts to be of little use in a phase of low interest rates. This is due to the fact that under these circumstances you will only receive low interest on your savings. By the time the savings phase is over, property prices may have risen again. Especially in top locations in cities such as Düsseldorf or Paris, a trend towards permanently rising prices for residential property can be observed. Higher prices after the savings phase in turn require higher borrowed capital. You can also secure low interest rates in the longer term by choosing an annuity loan with a long fixed interest rate period (of 20 or 30 years).
Conclusion and final remarks
Today, buyers and developers can find the right financing model for almost all real estate projects and personal circumstances. Irrespective of the type of property you are interested in, an intensive study of the loan and financing forms in advance is essential for careful consideration. Since large sums of money are involved in acquiring real estate, especially in top locations and larger cities, you should not only ask a house bank for the conditions. Instead, it is always advisable, in the best case, to obtain several offers and compare them carefully. Even if you do not want to change your bank, you may be able to obtain more favourable conditions from your own bank by obtaining favourable offers from outside. You should compare these with calm and care. Not only different providers, but also their respective products differ and are suitable for different purposes.
An important question you should ask yourself beforehand is what is the maximum amount of borrowed capital that you should be able to repay or redeem on time without excessive financial cuts.
The framework conditions should be right both when the offers are first obtained and when the subsequent comparison is made. To enable an objective comparison to be made, you should compare the different types of financing and decide what is suitable for you. Then you need to find the most sensible offer within the chosen type of financing (e.g. annuity loans).
For further information, we would be happy to refer you to our network partners for property acquisition in Düsseldorf or Paris. As a real estate agency, we are specialized in premium properties in Paris and Düsseldorf. Please do not hesitate to contact our partner bank or partner building society under the following options. In a personal meeting you will find out which form of financing and conditions are best suited to your individual needs.