Construction loans: some considerations to be aware of

The construction process can be tremendously satisfying to behold, as you watch a steel frame and a concrete slab transform slowly into a new home. If you are building a new home from scratch, then you will likely need a construction loan to finance the process, and there are a number of key things to be aware of before you apply for one.

What is a construction loan?

A construction loan is a loan that is specifically designed for people who are building a new home, or conducting major renovations on an existing property. It is distinct from other types of home loans, which are typically designed for those purchasing properties, either as owner occupiers or investors.

How is a construction loan different from a normal home loan?

A key difference between construction loans and other kinds of home loans is in the way that they are structured. They generally operate with what is known as a ‘progressive drawdown’ or ‘progress payments’, meaning that the funds will be released in stages, as different milestones are hit in the construction project, rather than all in one go. This means that you will only pay interest on the amount of the loan that has been released, not the whole amount. Some lenders may even offer construction loans that are interest-only during the construction period, and revert to principal and interest once the project has been completed.

What are the milestones for a construction loan?

According to a Canstar review of major lenders including CommBank and Westpac, the five typical stages at which the funds for a construction loan are released are:

  1. the laying of the slab or foundation
  2. the raising of the frame
  3. the ‘lockup’ period when a house has external walls and lockable widows and doors
  4. the fit out period when fittings and fixtures are installed
  5. completion of the project.

What are some things to be aware of with construction loans?

According to a Canstar review of major lenders and their construction loan offerings, there are a number of specific things to be aware of. In particular, it is important to understand the extra paperwork that may be required when applying, whether your lender imposes fixed construction periods, charges progress fees, has  restrictions that can be placed on owner–builders, or offers flexibility if you need to vary the contract.

Extra paperwork

In addition to the standard documentation that lenders generally want to see when you apply for a home loan, you will need to provide extra documentation when applying for a construction loan. Lenders will typically ask to see details  such as council plans and permits for the construction; and your fixed-price contract (if you are working with a builder), or your progressive payment schedule (if you plan to do the work yourself), as well as your insurance provisions.

Fixed construction periods

When applying for a construction loan, it is important to find out if your lender places restrictions on the time you have to finish the project, and if so, how long you will have. The time for a project can range from six to 24 months or longer, depending on the lender and the size of the project, and you may also be required to start construction within a certain time after settling on the purchase of the land.

Progress fees

It is also important to establish what fees your lender charges throughout the various stages of construction. Canstar research suggests some lenders may charge a fee at each stage of the construction process, when funds are released, which means you could end up paying up to five lots of fees throughout the building process. Other lenders may only charge a one-off flat fee for a construction loan, so it is important to ask about this upfront. 

Owner–builder restrictions

If you are an owner–builder and plan to build your home yourself rather than engaging an outside contractor, lenders may view you as riskier, based on fears you may go over your budget or not complete your build. A lender may ask for a detailed breakdown of your projected building costs and ask a professional such as a quantity surveyor to review them, to confirm their accuracy. You may find that you are charged a higher interest rate as an owner–builder than if you were to employ an outside contractor.

Contract variations

Any construction project can be prone to delays, whether because of bad weather or an unforeseen change to the plans. If there is any change to your plans, you will need to inform your lender, Irrespective of whether the change is minor or significant. If the change warrants it, your lender may reassess and re-evaluate the whole project. As a result, your lender might, for example, increase or decrease the amount of money they are willing to lend you.
Compare Home Loans with Canstar

If you’re currently considering a home loan, the comparison table below displays some of the construction home loans on our database with links to lenders’ websites that are available. This table is sorted by Star Rating (highest to lowest), followed by comparison rate (lowest-highest). Products shown are principal and interest home loans available for a loan amount of $400,000 in NSW with an LVR of 80% of the property value paying principal and interest. Consider the Target Market Determination (TMD) before making a purchase decision. Contact the product issuer directly for a copy of the TMD. Use Canstar’s home loans comparison selector to view a wider range of home loan products. Canstar may earn a fee for referrals.


Cover image source: Balance Form Creative/

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