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:
- Current debt on the land loan (if there is one)
- Your ability to service a construction loan as it’s being drawn down for progress payments.
- 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!