Construction Loans

If you’re looking to build a new home or make some pretty major structural changes to your existing home, then you should look at something like a construction loan. While a construction loan is a type of mortgage, they aren’t set up the same way, at least in the beginning.


What are construction loans?


This type of home loan is designed to provide you with funds to build or renovate your home. Depending on how your construction loan is set up, there will be varying conditions that need to be met throughout the construction of the home.

It can seem overwhelming and there is a lot to consider.

This is why talking to a qualified mortgage broker before you begin this process is key to ensure you get the right type of home loan that suits your specific needs. Often, a lender will need to look at the total amount you need to borrow to cover builder fees as well as the amount you’ll need to cover progress payments during the building process.

It’s important to remember, a construction loan will only cover the costs of a build or major renovation of a property. It will not cover the purchase of land or any other mortgage you might have in place. You would need to secure a separate home loan to take care of these, although you can combine them all into one mortgage once the building phase is completed.


Getting a construction loan


One of the key components for getting accepted for a construction loan is your ability to service the loan.

Lenders need to assess two things when looking at your ability to pay the loan:

  1. Current debt on the land loan (if there is one)
  2. Your ability to service a construction loan as it’s being drawn down for progress payments.
  3. The final part of the equation is that a lender will also review your ability to service the loans once they are combined (if applicable).

If you want to ensure you can get approval for a construction loan, it’s important that you have a clean credit history BEFORE you apply.

Construction loans can be hard to achieve without this, so it pays to put some forethought into paying down debt and cleaning up your credit history before you go down this path.

You’ll also need to ensure you can provide strong evidence of savings. 3 months isn’t going to cut it — lenders will want to see at least 12 months worth of savings history or that you own the block of land already (or at least a substantial amount of it).

There are number of elements to a construction loan to consider. A lender will want to see the following items from you:

  • Council approved plans
  • Contract to build with builder (typically a fixed price contract)
  • Builders Insurance
  • Builder’s Licence to build

These are your minimum requirements. If you can’t access these, then a lender won’t approve you nor will they advance funds. It’s time to get serious and dot “I’s” and cross “T’s”.

Why all the fuss you might be wondering? Well, as we’ve already identified, a construction loan is a very different product and because of this, lenders want to assess their risk more carefully.

The other reason that lenders are a little risk-averse when it comes to a construction-type loan is that these are typically interest only loans. This means that you would only pay the interest portion on the amounts being advanced, although this will depend on your lender.

This is a great asset to you during this stage of building, as it frees up you’re your personal cash flow, allowing you to deal with other things, like interior design requirements.

But be prepared… once the loan switches to a standard-type mortgage, you’ll likely be repaying principal and interest each month, which can be quite a shock to the system when you’ve been paying interest only for 12-24 months!


Compare Construction Home Loans


How do they work?


Typically a construction loan is advanced in stages, generally in line with the builder contract. The number of stages varies depending on the lender, but typically five stages are used to determine payments. These could include:

  1. Foundation
  2. Frame and Brickwork
  3. Lock Up
  4. Second Fix (plastering etc)
  5. Completion

Funds are advanced to your builder as each key stage is completed. Before funds are released to the builder at each stage, a qualified valuer may visit the site to make sure that the work being progressed is according to plan.

Their job is to make sure that the progress payments being released match the stage the build is at.  This will provide both the bank and buyer with a level of confidence that the construction is proceeding as planned.


How a construction loan might look in practice:


Meet Katie and Tim. They’ve been thinking about the plot of land they purchased 5 years ago for $250,000, wondering if now is the time to think about building. They’ve been looking at some display homes and chatting with a few architects and builders as well, figuring out what steps to take next.

They quickly realise that they need to chat with their mortgage broker BEFORE they can initiate the construction process. They’ve worked out that they’ll probably need $300,000 to cover the design and building costs.

After being approved for their interest only construction loan, the first payment advance is $50,000. This means that they are only paying interest on this advanced amount, not the full $300,000.

 The approximate interest payment would be $76.73 (per fortnight), based on a variable interest rate of 3.99% and a 3-year term.


Construction / Renovation Progress


When building, invariably there are likely to be alterations to a build contract. It could be as simple as a colour change to a wall, which often has little, to no price impact, through to something more significant like adding an additional room or making changes to window placement.

Provided it is nothing too significant, your fixed price construction contract should be able to handle minor changes. It’s important to be aware, so that you can avoid these types of contracts, that lenders are very reluctant to lend on contracts, which are either cost+ or an hourly/day charge.

Understanding how a construction loan works is the first step in helping you achieve your dream home or make renovations to your existing home. The next is to decide on a builder and get the ball rolling.

Let Australian Credit and Finance help you find the right construction loan so you can “build the dream” today…

Talk to our friendly team of Australian Credit and Finance mortgage experts who can help you navigate your way through the process of buying a home, investing in property or refinancing your home loan. Call us today on 1300 735 557 to discuss your construction home loan options.