A construction loan is one you might apply for if you were looking to build a new home, or to make some major structural changes to your existing home. Generally construction loans are written as a land and construction loan, where the borrower applies for a loan to cover cost of the purchase of land and the construction of the property at the same time.
Bundling the land and construction fees into one loan removes the risk for the lender that the finished dwelling could be valued less than the loan size (land and building costs). 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.
Instead of your lender providing you with the full loan amount once the loan is settled, construction loans are typically advanced in stages, called ‘progress draws’.
The number of stages can vary, but there are typically 5 stages used to determine payments. Depending on your lender they can include:
Foundation - levelling and laying foundation
Frame and brickwork - roofing and insulation
Lock up - securing the structure with windows and doors
Second fix - plastering and sealing
Completion - painting, installing appliances and fittings
The money is advanced to your builder upon completion of each stage, in-line with the builder’s contract.
To ensure work is being completed according to plan, and that the payments being advanced align with the stage the construction is at, your lender may send a qualified valuer to visit the building site.
As you’ll be given funds in installments, most lenders will typically only require you to pay interest on the amount you have drawn.
For instance, if you are given a $500,000 construction loan but have only drawn $100,000 of it, you will only pay interest on that $100k. This means you actually save money in interest payments throughout the construction.
Once construction is complete, and all progress draws have been made, you’ll then begin making full principal and interest payments on the loan. You can also choose to have your construction loan converted into an ordinary home loan at this stage, or combine it with other loans.
When building, it’s not uncommon to see alterations made to the building contract.
If your change is minor and should not have a major price impact you can try to pay for it yourself to avoid any changes to your loan contract.
However, if you want to make structural changes such as adding an additional room or making changes to window placement, you’ll need to speak to your lender. If your lender needs to reassess your loan, your build may encounter delays.
Lenders are typically more cautious when it comes to construction loans. It’s a very different product to standard home loans and lenders want to assess their risk more carefully. That’s why applying for and getting approved for a construction loan is a more complex process.
Firstly, you’ll need to choose a lender. It’s a good idea to shop around for the best rate with multiple lenders. If you’re not sure where to start, ask one of Lendi’s Home Loan Specialists for advice. They can sort through hundreds of options to find a construction loan that fits your specific situation.
As with most loans, your lender will want to ensure you have a clean credit history, so it’s important to spend time getting your finances in order. Pay any outstanding bills, taking care of any debts and cleaning up your credit file as best you can before applying.
Your lender will also require evidence of your ability to save. Most will require you to show 3 months of genuine savings and some will even accept 12 months of renting in lieu of genuine savings with the deposit being gifted.
Another way of gathering a deposit is with a family guarantee. This is when either a parent or close family member uses some of the equity in their own home as security for your home loan. Guarantors do not help with repayments so you will need to show that you can meet the repayments yourself, however if you default on your repayments, your guarantor will also be liable to repay the funds.
Not all lenders will accept a family guarantor and those that do have specific requirements in regard to applications of this kind to ensure that the guarantors are aware of their obligations and are protected.
Low on a deposit? We could have the home loan for you.
One of the key components to getting approved for a construction loan is your ability to repay the loan. Your lender will review your income and expenses as well as your employment history. They will be looking for evidence of a steady income stream and work history in the form of recent payslips and group certificates. Lenders need to know that you will be able to meet the repayment requirements once construction is complete and you move from making interest only repayments to principal and interest repayments.
Your lender will also want details of your building plans. Lenders want to make sure that the value of the completed property will not be lower than the loan size. A lender will usually request the following items from you (most registered builders will be able to provide you with these):
Council approved plans
Contract to build with builder (typically a fixed price contract)
Your builder’s licence
Think home loans are a headache? Chat to a Lendi Home Loan Specialist for free expert advice.
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 Home Loan Specialist 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 construction loan, the first payment advance is $50,000. Since this is the first progress draw, 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.
Your lender will usually arrange a final property inspection to take place to confirm that the property is finished to the proposed specification.
Construction loans are generally written as principal and interest (P&I) loans, however during the construction period repayments are interest only (I&O). Construction periods generally range from 6-12 months. Once construction is complete, the borrower will begin making principal and interest repayments. This is usually required one month after the final progress payment has been made.