Construction Financing
Types, Possibilities, and Suitability for Builders
Every real estate purchase or house construction comes with its own set of challenges. It is rarely 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 such as Düsseldorf or Paris, a real estate loan or other form of financing is required. Financing options range from traditional annuity loans and full repayment loans to building society savings agreements and hybrid forms such as combined building society loans.
All these options serve as a financing basis for you as a future homeowner to realize your project. This raises the question of which form of financing is the most suitable solution for which project. Knowledge of how the different types of financing work and their terms and conditions is an important prerequisite for making an informed decision between a real estate loan, a building society savings agreement, or a hybrid form.
Annuity Loan (Traditional Bank Loan)
The term "annuity loan" refers to one of the most commonly used methods of construction financing. It is a classic bank loan that is particularly often used in residential construction or real estate acquisition. A characteristic feature of this type of financing is the ongoing repayment of the loan. As the borrower, you must therefore repay the loan in fixed, equal amounts (annuities). This gives you, as the borrower, a certain degree of planning security throughout the entire term of the construction financing. The annuity of the loan essentially consists of the repayment amount agreed at the outset and the interest portion. The respective repayment amounts are calculated periodically. For this reason, the interest on the remaining loan balance decreases.
As a builder, You Benefit from this:
The loan installment remains constant, while the repayment portion increases continuously. The interest portion thus decreases over time. As a borrower, you can use the rule of thumb that the faster you repay the mortgage, the cheaper it is. With a conventional annuity loan, there is typically a residual debt at the end of the fixed interest period. This requires follow-up financing. Follow-up financing is required whenever the loan has not been repaid in full by the end of the mortgage term. In the case of long loan terms spanning several decades, it is rarely clear in advance whether and under what circumstances or conditions follow-up financing will even be possible. An alternative can be found in full repayment loans.
Full Repayment Loan: No Remaining Debt at the End of the Term
The full repayment loan is a special type of annuity loan used in construction financing. A characteristic feature of this type of real estate loan is that you have no remaining debt at the end of the agreed loan term. A typical feature is that the loan is taken out with a comparatively long fixed interest rate. The loan installment is also determined at the beginning of the loan and remains unchanged throughout the term.
As a borrower, you always benefit from a special right of termination after ten years of the fixed interest rate with this form of construction financing. It is therefore also possible to refinance the full repayment loan under these circumstances.
With a full repayment loan, there is only one fixed interest rate phase. At the end of this phase, the loan amount is usually repaid in full. This means that you do not need to arrange follow-up financing. The loan installment calculated in advance and the repayment amount determined in advance give you a high degree of planning security as a borrower. It is also common for lenders to grant a certain interest rate discount when a full repayment loan agreement is concluded.
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. The terms of this type of loan are often between 10 and 20 years. It is possible to shorten the term because you typically pay significantly higher repayment amounts than with a regular annuity loan.
Construction Financing with a Building Society Savings Agreement
Another very common method of construction financing is the building society savings agreement. With building society savings, you as the saver conclude a contract with a contractual partner (for example, a building society) covering three phases: the savings phase, the allocation phase, and the repayment phase. During the savings phase, you as the saver pay into a building society savings agreement. These payments are made in monthly installments that are determined in advance. The aim of the savings phase is to reach a defined savings amount. This is followed by the allocation phase. Here, the saved building society amount is paid out and supplemented by (particularly low-interest) loans, so that you have capital to finance your real estate project.
Once the desired property has been financed, the repayment phase begins. During this phase, you repay the loan amount to the building society in monthly installments. With a building society savings agreement, you can either use it in the traditional way or combine it with an interest-only advance loan. A building society savings agreement is a suitable instrument for securing interest rates. When combined with an annuity loan, the future remaining debt remains protected against interest rate increases. It should be noted that with a building society savings agreement, the allocation date can never be certain. Building societies are not allowed to promise or guarantee such a date to you as a customer. You should also expect to pay a follow-up fee.
Combined Financing: Combined Building Society Loans
As a combination of a building society savings agreement and a real estate loan, combination loans offer an alternative financing option for purchasing real estate. Building societies offer this option as a way of pre-financing the subsequent payout from the building society savings agreement. It is therefore a combination of an interest-only loan or advance loan and the actual building society savings agreement. The main difference to traditional bank loans is the different repayment concept. For the advance loan combined with the building society savings agreement, only the interest has to be paid. As a building society saver, you transfer the respective savings installments to the building society savings agreement instead of making repayments. When the building society savings amount is finally allocated (for example, after ten years), you use it to repay the advance loan. Typically, the components of the combined building society loan are coordinated in such a way that both the installments and the interest are fixed for the entire term of the agreement.
When the building society contract matures, the entire building society sum is paid out to the credit institution that granted you the loan. This means that the advance loan is repaid in full and you, as the borrower, then only have to repay the building society loan, including any interest incurred, to your building society in monthly installments. The building society loan usually amounts to 60 percent of the total savings amount. This offers a time advantage over a regular building society contract. It should be noted that, in practice, you pay interest twice for this time saving, which relates to practically 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 contract). Then you pay interest again on the building society loan, i.e., on 60 percent of the advance loan amount.
Choosing 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 appropriate loan or other form of financing can be determined by carefully considering the financing challenges as well as your interests and resources. Buyers and builders can find the right model for their project for almost all financing needs.
In order to narrow down the types of financing available to you, you first need to determine what type of real estate financing you are looking for. If you are financing a property for the first time or already own one and are planning to purchase another, you will need new financing. If you have already started financing a property and the fixed interest rate period is coming to an end, then follow-up financing for the property will be relevant. You may also be planning to purchase a property using equity (which may be available, for example, from the sale of another property). You may not have the equity available at present. In this case, interim financing is advisable. The choice of financing type depends not only on personal circumstances, but also on interest rates and conditions. Many experts consider building society savings agreements to be of little use in a low-interest phase. This is because, under these circumstances, you will only receive low interest on your savings. By the time the savings phase is complete, real estate prices may have risen again. In prime locations in cities such as Düsseldorf or Paris in particular, there is a clear trend toward permanently rising prices for residential property. Higher prices after the savings phase in turn require more borrowed capital. You can also secure low interest rates in the longer term by choosing an annuity loan with a long fixed interest rate (20 or 30 years).
Conclusion and Final Remarks
Nowadays, buyers and builders can find the right financing model for almost all real estate projects and personal circumstances. Regardless of the type of property you are interested in, it is essential to thoroughly research the various types of loans and financing options in advance in order to make a careful decision. Since real estate purchases involve large sums of money, especially in prime locations and larger cities, you should not only ask your own bank about the terms and conditions. Instead, it is always advisable to obtain several offers and compare them carefully.
Even if you do not intend to change your primary bank, you may be able to negotiate more favorable terms with your own bank by presenting them with attractive offers from other banks. You should compare these offers calmly and carefully. Not only do different providers differ, but their respective products also differ and are suitable for different purposes.
An important question you should ask yourself in advance is what the maximum amount of borrowed capital should be so that you can repay or redeem it on time without excessive financial hardship. The framework conditions should be right both when you first obtain quotes and when you subsequently compare them. To enable an objective comparison, you should first compare the different types of financing and decide which one is right for you. Then you need to find the most sensible offer within the chosen type of financing (e.g., annuity loan).
For further information, please refer to our network partners for real estate purchases in Düsseldorf or Paris. As a real estate agency, we specialize in premium properties in Paris and Düsseldorf. Please do not hesitate to contact our partner bank or partner building society using the options below. In a personal consultation, you will find out which form of financing and conditions are best suited to your individual needs.