What is a construction home loan?
A construction home loan is a type of home loan designed for people who are building a home as opposed to buying an established property. It has a different loan structure to home loans designed for people buying an existing home.
A construction loan most commonly has a progressive drawn-down. That is, you draw down the loan (or increase your borrowing) as needed to pay for the construction progress payments.
The amount available to borrow will be partly based on the value of the property upon completion of the construction.
A construction loan will usually be interest only over the first 12 months and then revert to a standard principal and interest loan.
Of the 95 lenders on Canstar’s database as of March 2017, 83 offer construction loans. Here’s how they work, and where to find an outstanding value construction loan.
How do progress payments work?
Once a construction loan has been approved and the construction of the property is underway, lenders will make progress payments throughout the stages of construction.
Generally, the payments will be made at upon completion of five stages:
(1) Slab down or base: This is an amount to help you lay the foundation of your property. It covers the levelling of the ground, as well as the plumbing and waterproofing of your foundation.
(2) Frame stage: This is an amount to help you build the frame of your property. It covers partial brickwork, the roofing, trusses, and windows.
(3) Lockup: This is an amount to help you put up the external walls, and put in windows and doors (hence the term ‘lockup’, to make sure your house is lockable).
(4) Fitout or fixing: This is an amount to help you do the internal fittings and fixtures of your property. It covers plasterboards, the part-installation of cupboards and benches, plumbing, electricity, and gutters.
(5) Completion: This is an amount for the conclusion of contracted items (e.g. builders, equipment), as well as any finishing touches such as plumbing, electricity, and overall cleaning.
As the loan is being progressively drawn down, interest and repayments are calculated based only on the funds used so far. For example, if by the third progressive payment, only $150,000 has been drawn down on a $300,000 loan, interest would only be charged on $150,000.
It is also important to note that most banks require you to use all of your equity before they release the next payment.
Considering construction loan options? We have provided comparison tables that displays principal and interest building home loans with direct links to the financial providers website. Here you can view options for either variable sorted by star ratings (highest to lowest). For further information, try our comparison table function for yourself and compare home loans. Please note that this table features products that are based on a loan amount of $350,000 with a LVR of 80%, under a building profile in NSW.
Can you use a ‘standard’ home loan instead of a construction loan?
Yes – provided you have sufficient equity in an existing standard home loan to be able to borrow the amount that you need without using your to-be-constructed house as security.
If you have enough equity in a loan on the block of land itself, or in other assets such as invest properties, then you could redraw the funds for your construction loan, whether progressively or all at once.
The advantage of redrawing from an existing loan is that you are able to pay construction costs as and when they fall due, including smaller incidental costs along the way. This is a particular advantage for owner-builders or those who are DIYing some portion of the construction.
A potential disadvantage is that by fully drawing the home loan from day 1, you are also paying interest on the loan from day 1. This can be mitigated by placing any not-yet-spent construction money in a 100% offset account against your loan.
While the rates on construction loans might be slightly higher at first, you can refinance it into a permanent mortgage once construction is completed, which can come at a lower rate if you shop around.
Building a home is not without its headaches – financial and otherwise. There are pros and cons to both building a home and buying an existing home. Getting the right loan structure in place, though, will help to smooth the process.
Considering construction loan options? We have provided comparison tables that display our low rate, principal and interest building home loans with direct links to the financial providers website. Here you can view options for either variable, or 3 years fixed loans, sorted by comparison rate (lowest to highest). For further information, try our comparison table function for yourself and compare home loans. Please note that this table features products that are based on a loan amount of $350,000 with a LVR of 80%, under a building profile in NSW.
Variable Building Home Loans
3-Year Fixed Building Home Loans
How to get a construction loan
Getting approved for a construction loan is a different process to applying for a standard home loan on an existing home.
The first thing you’ll need to do to ensure a smooth application process is to present the lender with professional plans for your property. A property appraiser will then go over these plans to determine the expected value of the property when completed.
This is because when you apply for a construction loan, the lender considers the expected value of the property upon completion of construction as well as the total amount required to borrow in order to pay the builder.
Once this has been done, the lender will then ask you to approve a loan offer for the property. You will then have to make a deposit, as you would with most other types of home loans. This acts as a security at this stage of construction, and a larger deposit will convince your lender of your trustworthiness.
For each stage of the construction process listed earlier, you’ll have to confirm that the work has been done, complete and sign a drawdown request form, and send it to the construction department of your lender.
Owner builder mortgages
One type of construction loan is an owner builder mortgage, which is a specific type of loan designed for people who intend to build the house themselves without the help of a professional builder.
Lenders are hesitant to accept applications for these loans, as they use the property as security against your mortgage. If you’re building this property yourself, they will consider you to be a higher risk.
Lenders who do give owner builder mortgages will usually limit the Loan-value-ration at 60%, causing you to pay a deposit of at least 40%.