What is a construction loan?
A construction loan is a type of home loan designed for people building a home or doing major renovations, as opposed to buying an established property. They’re a unique form of loan with a different structure to standard home loans.
How do construction loans work?
A construction loan normally has a ‘progressive drawdown’. This means the loaned funds are paid out – generally directly to your builder – in instalments at various stages of construction, rather than all at once at the start. You typically only pay interest on the amount that’s been drawn down at a given time, as opposed to the whole loan amount.
Drawdowns typically happen at set stages of a project, like when your slab is being measured and poured, when your home’s walls, electrics, and plumbing are being installed, and when the internal fittings are being attached.
A number of lenders offer construction loans with interest-only repayments during the construction period that then revert to standard principal and interest mortgages once your home is built.
If you’re taking the loan out for renovations or to build your next home, some lenders may ask you to make contributions towards the cost of construction from your savings or to provide evidence you’ll be able to afford repayments on both your existing home loan or bridging loan and your new construction loan, even if you’re accessing equity you have built up in your current home.
Can I use a construction loan to build a new home before selling my current one?
The way you approach this will depend on your financial situation. If you’re selling your existing property to fund your new one but want to live in it while construction takes place, you’ll generally need to combine your construction loan with a bridging loan. A bridging loan is a short-term loan designed to carry the debt of both properties while your new home is being built.
While building your new home, many lenders will allow you to make interest-only repayments on the total combined debt to keep your repayments manageable. Once the build is complete and you sell your original property, the sale proceeds will be immediately used to pay off the bridging loan, leaving you with a standard mortgage on your brand-new home.
How do progress payments work on a construction loan?
Once a construction loan has been approved and building has started, lenders will generally make progress payments at various stages of the project. Progress payments will typically be paid directly to the builder at the completion of each stage. As the borrower, you’ll also be making regular repayments to your lender, just like you would with any other home loan.
Some of the typical stages or milestones at which a lender may make progress payments under a construction loan include:
- Slab down, foundations, or base: This is when your builder lays the foundation of your property. It can cover the levelling of the ground, as well as the plumbing and waterproofing of your foundation.
- Frame: This when your home’s frame is being constructed. It can cover partial brickwork, roofing, trusses and windows, as well as insulation.
- Lockup: This is when the external walls are being constructed, as well as the installation of lockable external windows and doors (hence the term ‘lockup’).
- Fitout or fixing: This is when your builder instals the internal fittings and fixtures of your property. It can cover plasterboards, the part-installation of cupboards and benches, plumbing, electricity, and gutters.
- Completion: This is the final payment provided when finalising contracted items (like final payments for builders and equipment), as well as any finishing touches such as fencing, painting, and overall cleaning.
Who has the best construction loans in Australia?
There’s no one ‘best’ construction loan provider – the best loan for you will depend on your financial circumstances, needs, and personal goals.
To find the best construction loan for you, ask yourself:
- Do you need the loan to construct a new home or renovate an existing one?
- Do you need the loan amount paid in instalments and at what stages of the build?
- Do you also need a bridging loan if you’re building a new home while still paying off your current one?
- How much do you need to borrow?
- How soon do you need the money?
- How much can you afford in repayments?
- How long would you be willing to be in debt for?
- Can you fulfil a lender’s eligibility criteria?
- If you’re renovating, are there any alternative credit or finance options available to you (like using your savings, establishing a line of credit in your current home loan, or taking out a personal loan)?
Once you know what you’re after, you can use the comparison table above to view a variety of construction loan options on our database.
How to get a construction loan
Getting approved for a construction loan is generally a different process to applying for a standard home loan.
You’ll typically need to provide your lender with documents, including council-approved plans and building specifications, a copy of your fixed-price building contract with a licensed builder, and any applicable insurance documentation (like a copy of your builder’s public liability and risk insurance).
You’ll also be subject to normal lending criteria, meaning you’ll need to provide details of your income, expenses, and existing assets and debts.
It’s likely a property appraiser will then estimate the expected value of your property when completed. Your lender may need this valuation when determining your equity, as well as when registering the property as a security for the home loan. Further property valuations and inspections will usually be required after each payment stage.
If your loan is approved, your lender will supply you with the loan contract. Once signed, you’ll need to make a deposit, which acts as a form of security at this stage of construction. A larger deposit can help to convince your lender that you’re a less risky borrower. You’ll typically need a deposit, likely of at least 5%, keeping in mind that you may have to pay lenders mortgage insurance (LMI) if your deposit is less than 20%.
For each stage of the construction process, you’ll usually 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. Your lender may also request an invoice from your builder for the cost of the work done.
What are some of the benefits of a construction loan?
A construction loan can allow you to access your loan amount in instalments when you need it, helping you save on interest until the building is complete. Some lenders also offer interest-only repayments during the building stage, meaning you could face lower repayments, improving your cash flow, which may be handy if you’re renting while your new home is being built.
What are some of the risks of a construction loan?
Like any lending product, a construction loan comes with risk. If property prices fall while you’re building, you may be left with less equity than you anticipated, or even negative equity should your new home be worth less than what you paid to build it.
You could also find yourself at the whim of the building industry. If your builder goes into liquidation or you’re affected by major weather or labor delays during construction, your loan agreement doesn’t suddenly pause or disappear. You’ll usually still need to make your repayments while looking for a new builder or waiting for work to resume. This may be tough, especially if you’re paying rent or making repayments on another loan.
If you make changes to your home’s design or fixtures mid-build, or if your builder uncovers unexpected issues (like hitting rock during excavation), these extra costs will rarely be covered by your construction loan. Lenders base your loan strictly on the initial fixed-price contract, meaning you’ll generally have to pay for any of these variations directly out of pocket.
