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Construction loans and owner-builder mortgages

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

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If you are looking to build your new home rather than buy an existing property, you need a different type of mortgage known as a construction loan. A construction loan may also suit if you are making major renovations to your existing home or a property you have bought but which needs a bit (or a lot) of work before you call it home.

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 the way a construction loan is set up, you may be able to purchase a vacant block of land first and then arrange to build on the land 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 full 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 progress draws are being made, the majority of lenders only expect you to pay the interest due on the amounts that have been drawn. Full principal and interest payments don’t begin until after handover has taken place and you receive the keys to your new home, meaning you save on interest during the construction process.

Owner-builder mortgages

An owner-builder or self-build mortgage is designed for those people who wish to build their own home without the help of a licenced builder. 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 home loans.

Additionally, those lenders that do offer owner-builder mortgages usually limit the loan amount to 60% of the total land value and construction cost. The lender takes into account 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 value of the security property 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.

Who needs a construction loan?

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

Property developers for small scale developments may also use construction loans, but these might only be available if you’re building below a certain number of properties. If you’re building a higher number of properties (usually over four) most lenders consider this to be a larger-scale development, which instead requires commercial finance.

What you need to consider about construction loans

Due to the inherent risks involved for the lender, construction home loans are normally only offered to borrowers who have an extremely good credit history. The eligibility criteria is much more stringent for construction home loan applicants than it is for borrowers applying for a more traditional mortgage. The initial down payment required is usually quite significant, especially if the building lot is not of great value without a building on it. Most lenders want at least 20% of the total cost put down as a deposit.

However, it’s not just the cost you need to consider before choosing to build. There are a number of other factors you should be aware of 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. It’s only when you sign a building contract with your licenced builder that you 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?

The vast majority of banks and lenders prefer that you choose a licenced builder to construct your home before they extend a construction loan. However, there are some lenders that 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:

  • It helps to 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 your finance application isn’t approved 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 being approved with a specific lender for no more than a specific interest rate and that your finance approval needs to be received by a specific date. Remember, in this instance, your finance approval is the full formal approval or unconditional approval from your bank.

The primary reason for adding specific 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?

There are some cases where 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 especially difficult because the builder has to reassess the value of the loan 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 completed 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, which makes it easier for the bank to make changes and to prevent delays.

How to choose a construction loan

Just like a regular mortgage, the way you compare construction loans has an impact on 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 take into account the fees you pay for the loan, so be sure to also look at the comparison rate, as this reflects the true cost of the loan.
  • Fees. Some construction loans have extra fees which are charged 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. During the construction phase, most features of your home loan are unavailable, 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 the construction phase is finalised. 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


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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