Construction loans are designed to see your home building through from concept to completion. Here's how they work.
Obtaining an appropriate construction home loan can be complicated, but it's worth the trouble once it all comes together and your brand new home has been completed to your specifications.
You'll need to follow a few steps for your construction home loan before work commences, and once it's approved there are five stages at which your lender will release payments, known as progress draws.
Before construction begins
Before you break ground on your new home, you'll need to get a few things in order:
- Draw up the plans. The first step is to have your plans professionally drawn up and fully costed before placing them before your lender for home loan approval. The lender will then have an appraiser complete a preliminary assessment of the assumed value once the house is completed from the plans you have submitted. Construction home loans require management by a local financier until the home is completed as such loans are not sold on the secondary mortgage market. After completion you can arrange to have the construction home loan converted to a regular home loan.
- Buy your land. Your next step is to either make a deposit to the lender or purchase the lot of land that the home is to be built on. This acts as sufficient security for the loan at this stage. The lender needs to see the level of your commitment to the project, and your equity in the project right from the beginning goes a long way in demonstrating this commitment. It will help if you own your building block outright.
- Shop around. Before committing yourself to the first offer made it will pay you to look around to see what other lenders are offering so that you can make a proper comparison. Construction home loan interest rates vary much more than rates on regular home loans, and can sometimes be as much as three percentage points higher.
- Cover yourself. You must take out a builders risk insurance policy to protect yourself and your lender against any storm or fire damage. This is important even if you have contracted the work out to a builder who has commercial liability insurance. You will need the extra cover to fully protect your own interests and that of your lender for total coverage.
- Consider your finance. Some construction loans are designed to finance the building of your home only, while others are framed around that of a more traditional mortgage. While the basic elements of the loan are much like any other, you may find it necessary to have the loan changed to a more traditional home loan after the construction is completed in order to get the range of benefits that a more flexible mortgage offers.
The five steps of construction
Once you've bought your land, decided on your plan and sorted out your finance, it's time to begin construction.
While a traditional home loan releases the full funds for your property purchase at settlement, a construction loan works a bit differently. Funds are paid in stages known as progress draws. These stages correspond to the progress of your home's construction.
1. Foundations and footings
At this stage of construction, the building site is cleared of any vegetation and debris, and is levelled. Footings for your house are installed and spaces are cut out for the site’s plumbing.
During this time, the concrete slab for your house will be poured. After this, initial plumbing and waterproofing will be installed.
All in all, you can count on this stage of construction taking about two weeks as the concrete for your foundation is allowed to dry and cure.
At the completion of this stage of construction, your lender will make your first progress payment to your builder. This will generally be around 10% of the total funds for construction.
2. Frame-up and brickwork
At this stage, the framework, trusses, roof and windows will be constructed. If your home has brickwork, this will be partially done. Gutters and insulation will also go in at this stage, as will any conduits for plumbing or electrical work.
This stage is longer than the initial foundation stage and is likely to take up to four weeks.
At the completion of this stage, the second progress payment will be made. This payment will account for around 15–20% of the total construction funds.
3. Lock-up stage
At the end of the lock up stage, your home will be sealed and protected from the elements. During the lock-up stage of construction, doors and windows will be installed. All exterior walls will also be completed.
The lock-up stage can take up to four weeks.
At the completion of this stage, your lender will make the third progress draw payment to your builder. This is one of the most significant drawdowns, making up 20–35% of the total building funds.
At the fit-out stage of construction, all fixtures, fittings and appliances will be added. This means plumbing and electrical work is completed, gutters and downpipes are installed, skirting boards, cornices and architraves are added, kitchen benches and cupboards are put in and shower screens, mirrors, sinks, toilets and faucets are put in place.
By now your house is starting to look like a home. The fit-out stage is where a significant amount of the construction of your home takes place. This stage can take up to six weeks.
At the end of this stage, your lender will make the fourth progress payment to your builder. This will account for 20–30% of the total funds.
5. Practical completion
Once the practical completion stage is over, you’ll have a finished house. It’s during this time that your builder will work on the finishing touches, including painting, any final electrical or plumbing work, final installations of appliances and any other detailing.
At the end of this stage, which can take up to eight weeks, you’ll do a final walkthrough of your property to identify any problems, and the builder will walk you through the property’s features.
Your lender will also do a final inspection before disbursing the final progress drawdown. This will be around 10–15% of the total funds. After this stage, your construction home loan will also be converted into a traditional home loan.
It’s important to note that this stage does not include some final works, such as pouring your driveway and completing landscaping. These works often aren’t included in a building contract, which means you may have to organise separate contractors for these jobs.
Nevertheless, at the end of this final drawdown, you’ll be able to move into your new home.
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