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Construction loans

Learn how to build the home of your dreams and save on home loan interest while you do it.

A construction loan is suitable if you’re looking to build a new home or investment property or substantially renovate an existing property. It differs from a regular mortgage because funds are released in stages as the construction of the property progresses.

What is a construction loan?

A construction loan is a specific type of mortgage designed for people wanting to build a new home. Depending on how a construction loan is set up, you may be able to purchase a vacant block of land first and then arrange to build on it within a specified timeframe.

Construction loans aren’t set up in quite the same way as a regular mortgage. Instead, the lender considers the total amount you need to borrow to pay your builder and then breaks down the total amount into separate payments called progress draws. These are a percentage of the total building contract amount paid from your mortgage funds to the builder throughout the construction process.

While you make progress draws, most lenders only expect you to pay the interest due on your draw amounts. For example:

  • The total house and land package value is $500,000
  • The land purchase price is $125,000
  • Your lender allows you to draw down $125,000 (25% of the loan)
  • Therefore, you are now making repayments based on 25% of the total loan value
  • When construction of the property is due to commence, you builder requests $100,000
  • Your lender releases another drawdown of $100,000 (20% of the total loan)
  • You have now drawn down 45% of the entire loan
  • Therefore, you are currently making repayments based on 45% of the total loan value

The more you borrow or draw down throughout the process, the higher your repayments become. Your total principal and interest payments won’t begin until after the handover, and you receive the keys to your new home, which means you save on interest during the construction process.

Owner-builder mortgages

An owner-builder or self-build mortgage is designed for those wishing to build their own home without the help of a licenced builder. However, as banks and lenders use the property as security for your mortgage, many of them consider owner-builder mortgages to be high risk. For this reason, many banks and lenders do not accept applications for these types of loans.

Additionally, those lenders that offer owner-builder mortgages usually limit the loan amount to 60% of the total land value and construction cost because the lender considers the value of the vacant land as part of the valuation total. However, you should note that the actual completed value of the home is rarely taken into account when factoring in the security property’s value with owner-builders. Instead, the lender looks closely at the quotes provided to form the estimated cost of materials and labour required to complete the construction.

How do I get started with a construction loan?

Construction loans are suitable for any borrower intending to build a new home on a vacant block of land, including buying a house and land package from a licenced builder or conducting significant renovations to an existing home, such as adding new rooms.

Based on your income, the first step is to work out how much you can afford to borrow for your construction loan.

Next, consider your financial position. Due to the perceived higher risks involved for the lender, the eligibility criteria can be much more stringent for construction home loan applicants than it is for borrowers applying for a traditional home loan.

The initial deposit required is usually at least 20% of the total construction cost, meaning you need this amount in savings.

There are several other factors to consider when choosing a construction home loan:

Do I need to buy a house and land package to get a construction loan?

You don’t technically need to buy a house and land package from one builder or developer to get a construction loan. You may have already purchased a vacant block of land using a regular mortgage. When you sign a building contract with your licenced builder, you then need a construction loan. Keep in mind that this way, you do end up with two separate mortgages.

Do I have to use a licenced builder to construct my home?

Most banks and lenders prefer that you choose a licenced builder to construct your home before extending a construction loan. However, some lenders allow you to build your own home as an owner-builder, which is ideal if you’re a qualified tradesperson or if you have a building licence of your own, but an owner-builder loan isn’t for the faint of heart.

What clauses are involved with a construction loan?

In some cases, you can include a finance clause when you sign your contract for a vacant block of land. This type of clause is quite common when purchasing vacant land or even an established home via private treaty sale (not at an auction), where you can insert a clause that says “subject to finance”.

The ability to include a finance clause provides several benefits:

  • First, it helps protect you against being forced to take out finance that isn’t suited to you.
  • It allows you to withdraw from your contractual obligation if you don’t receive approval for your finance application for any reason.
  • It removes the block of land from the market while the agent waits to hear about your finance approval.
  • It gives you time to obtain finance.

You may also be able to include specific dates and other information relevant to your clause. For example, you can add that your clause is subject to finance approval with a particular lender for no more than a specific interest rate. But, again, your finance approval needs to be received by a particular date. Remember, in this instance, your finance approval is your bank’s full formal approval or unconditional approval.

The primary reason for adding information like this is to protect against you having to accept finance that isn’t suitable for you or your situation. So, if you’ve already received a pre-approval from your lender and you already know your interest rate, you can enter this information into the clause.

What if a building contract changes?

In some cases, a lender makes a construction loan more expensive, which may be due to the contract price going up after you get an amendment on your home prepared. This situation can be challenging because the builder has to reassess the loan’s value from the top. However, you can do a few things to prevent this from being an issue down the road.

  • Ensure your building contract is complete and finalised before sending it to your lender.
  • Pay for any new changes or additions to the construction with your money. You can also ask your builder to reimburse you if you receive any discounts.
  • Consult your lender if the changes are massive. You might need to wait a month for the lender to review the loan.
  • Be sure to simplify your changes, making it easier for the bank to make changes and prevent delays.

How to choose a construction loan

Like a regular mortgage, the way you compare construction loans impacts the value you receive. Here’s what you should compare:

  • Interest rates. You only pay interest during the construction period, meaning the interest rate you receive has an important bearing on the size of your repayments. Keep in mind that the advertised rate doesn’t consider the fees you pay for the loan, so be sure to also look at the comparison rate, as this reflects the loan’s actual cost.
  • Fees. Some construction loans have extra expenses to cover the cost of having a valuer check your property after each completed stage of the building. Some mortgages also charge additional administration fees for construction loans, so you may need to factor this into the total cost. These fees are in addition to regular upfront charges such as application costs, valuation fees and more.
  • Features. Most features of your home loan are unavailable during the construction phase, such as redraw and the ability to make additional repayments (this, of course, depends on the particular loan). However, it still pays to know what features you can use once you finalise the construction phase, so find out what features you want from your home loan and ensure you search for these during your comparison.
  • Construction terms. You want to confirm what construction terms your loan offers, including how long you can build for, for example, 12 months, using the loan and the process for drawing down and accessing funds.

Tips to follow when building a home

Consider pre-approval

Always approach your bank or mortgage broker about pre-approval for your construction loan before you go out looking at display homes, as it lets you know exactly how much you can spend on the land and construction costs as a combined total. It is also a great way to ensure you don’t go over budget.

Check your builder’s licence

Always check that the builder you are considering has a valid building licence. Your local building licence office can help you with this. You should also check whether you can find claims anyone has made against that particular builder.

Get industry help when selecting a builder

If you’re unsure which building company to trust, always check with the Registered Master Builders Association.

Check your builder’s qualifications

Double-check that the builder you choose has their qualifications and insurance policies in place before construction commences. Your building contract should show whether the builder has arranged indemnity, public liability, and other insurance coverage.

View previous homes they’ve built

Ask the building consultant if they can give you details and addresses of previous homes they’ve built. The builder’s display home might look impressive, but you want to see the quality of a completed home.

Get an accurate estimate of how long it’ll take to build

Ask your builder how long the construction process takes. Remember, you’re paying interest on the progress payments for your mortgage throughout this time, so you need to know how long it will take. Some builders are happy to guarantee a specified timeframe for the construction process. Others are a little more ambiguous about how long it takes to build a home.

Find out what your bank expects when making drawdown payments

Check with your bank how they want you to approve your progress payments. Some banks allow you to verify this over the phone. Others expect you to sign progress payment forms that need to be faxed or emailed to the correct bank department before they can make payment. Double-check that you have the correct contact details; otherwise, your builder might not get paid on time, which could delay the construction process.

Compare and organise insurance

Before your bank finalises the last progress payment and gives approval for the builder to hand over the keys to your new home, they want to see that you have arranged adequate insurance coverage. So you need to call your insurance company and insure the property for the total replacement value. You also need to tell them which bank your mortgage is held with, as this appears on your insurance policy. When this is complete, ask your insurance company to provide you with a “Certificate of Currency”, which lists these details, and you can hand it to your bank.

FAQs about construction loans

Building your own home can mean you get everything exactly the way you want it, and with a construction loan, you remain in control of the building process at every stage.

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