So, you’ve decided to buy a new home – but the only issue is this home doesn’t exist yet and sadly, you don’t have a magic wand to produce your dream home on the perfect block overnight.
Alternatively, you’ve decided to renovate your current house or make several structural changes to it.
How will you pay for these plans?
This is where a construction loan comes into play.
How does a construction loan work?
A construction loan allows for all of the materials, labour and other expenses involved in building or renovating your house.
They’re often called land and construction loans, particularly if you’re buying the land itself as well as preparing to build a house on this site.
But while they’re similar to your standard home loan, there are some big differences between the two.
Firstly, a construction loan sees the lender paying out instalments of a pre-agreed loan amount to the borrower – rather than an immediate lump sum – in various stages of the property’s build or renovations.
Called ‘progress draws’, ‘progressive drawdowns’ or ‘progress payments’, these instalments are also different from standard home loans in that the borrower need only concentrate on interest-only (IO) payments.
For example, while your total construction loan amounts to $500,000, your first progress draw is $50,000 and as such, you only need to pay the interest on this $50,000, rather than the entire $500,000 loan.
These IO repayments – rather than your usual principal and interest (PI) repayments for a home loan – can therefore save you a bundle of cash.
You will have to think about PI payments eventually, but more about that later.
When do I pay my progressive loan payments?
These payments are usually based on about five to six construction loan stages and therefore need to be paid once these stages are done and dusted.
- Levelling and laying the concrete slab of the home and connecting basic plumbing and drainage.
- This stage will usually require about 15-20% of your total loan funds.
- This construction detail will give your new house its basic skeleton including insulation and roofing.
- Expect to pay around 20% of your funds for this stage.
3. Lock up
- As the name suggests, your home will enjoy full security after this stage with lockable doors and windows.
- How much should you pay for this stage? About 20%, give or take.
4. Second fix or fit-out
- Think plastering and sealing and the installation of internal fittings and fixtures such as lights, benches and cupboards.
- About 30% of your funds should cover you for this stage.
4. Completion and clean up
- This is the light at the end of your construction tunnel as builders install final plumbing and electricity points and also clean up the entire construction site.
- Prepare to hand out about 10% of your funds for this final stage.
What should I consider as construction progresses?
The construction of your dream home is progressing just as it should with even the weather staying kind and sunny.
But are you, your lender and your tradies also enjoying a kind and sunny relationship?
You definitely will be if, on the completion of each of the above stages, you swiftly submit all your tradespeople’s claims, invoices and similar paperwork to your lender.
Once the lender has checked and approved this paperwork, they will then advance you the agreed cash you need to pay to your tradespeople, just as you agreed to do in the builder’s contract.
The moral to the story is: ensure you’re ahead of the game – or at least keeping a very close eye on things – at both your construction site and with your lender.
What if things go pear-shaped?
It’s common for ups and downs to appear in the building journey, whether it’s a tradie not showing up or an unexpected cost somewhere, somehow.
If it’s a minor change, aim to pay for the cost yourself to save making changes to your loan.
But if it’s major – such as adding a new bathroom or similar – talk to your lender ASAP.
Also remember that even if your construction progresses beautifully, your lender may send a valuer to the building site throughout the journey to ensure everything is A-OK.
How can I get a construction loan?
OK, you’ve decided a construction loan is the way to go for you.
Well, think of the lender documents and details you needed for your standard home loan and then up the game even more because guess what?
Construction home lenders are even more conservative than standard lenders – and also more rare.
Also, how much you can borrow will depend on a completed property appraisal, including the market price of the potential home’s site.
But never fear – registered builders able to provide you with most of the following details:
- Council approved plans and permits
- Progressive payment schedule
- Industry-standard builder contract (usually fixed price)
- Your builder’s registered licence
- Your builder’s bank account details
- Construction site and workers’ insurance policies
You’ll also need all the documentation from your standard home loan application for a construction loan including:
- Credit history
- Proof of income, debt and savings
- Proof of deposit
- Employment history background
These points are particularly important as the lender needs to rest assured you can repay the loan even when you move to PI payments.
Pros and cons of a construction loan
After all your hard work so far, we don’t wish to see you head downhill but we do want to let you know the ins and outs of a construction loan.
- Your initial IO loan repayments make for big savings overall
- First-home buyers building a brand new home may be eligible for the expanded federal New Home Guarantee (NHG), with a further 10,000 places recently announced for the upcoming financial year
- You can build your house exactly as you want it to be
- A construction loan is specialised and owner-builder ones (see below) even more so, so not every lender will offer them
- The risk of such potential properties also means a generally higher interest rate is charged compared to your standard loan
Are you lucky enough to be a licenced builder – or know of one amongst your friends and family members – and can construct your own home?
If so, you can apply for an owner-builder construction loan.
They’re not easy to find and lenders are highly conservative about splashing cash on them including only offering higher than usual interest rates.
But it’s worth a shot.
Just remember your lender will need to see the following documentation as well as your usual loan documentation:
- Quantity surveyor report featuring expected costs and soil test details
- Construction costs
- Timing schedule
- Quotations, invoices and estimates
What happens after construction is completed?
The main difference in your construction loan now – besides the joys of moving into your brand new house! – is that you’ll start to pay a full PI loan when your lender releases your final splash of cash.
Your lender will also most likely request one last inspection before confirming the property is completed to the agreed specifications.
You may then choose to change your loan to a standard one at this point or refinance altogether.
We’re here to help
There’s no doubt construction loans make for an exciting period ahead.
Yet whether you’re brand new to the buying circuit or a savvy investor turning to a renovation or an adventurous construction, know that we’re on your side with a wealth of advice and assistance for you.
Our team of experts can find you the best possible deals – both standard and for a construction loan – plus we have more than 40 of Australia’s biggest banks and specialist lenders for you to choose from.
So, come to Lending Loop for top tips on finding a great lender for you!