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.
What to do first
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.
With most licensed builders, the contract should include a section outlining exactly what stages will be completed throughout the construction of your home. In most cases, there will be five stages:
Inside your building contract, you should see an itemised listing for each stage noted above. Alongside each stage will be a percentage number. This indicates what percentage of the total building contract amount is due to be paid to the builder after completion of each stage.
- Foundations/slab = 25%
- First fix = 20%
- Lock up/internal linings = 15%
- Second fix = 25%
- Practical completion = 15%
Your bank will work out exactly how much your building contract comes to, minus any deposits you've already paid to the builder and then divide up your total home loan amount to pay to the builder accordingly after each stage is complete.
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