Get a competitive construction loan to build the home of your dreams and learn how the construction finance process works (it's different to a normal home loan).
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Most Australian borrowers purchase existing homes and borrow the money to pay for them with home loans. But if you want to build your own home on an empty block of land you'll need a construction loan.
You can use a construction loan to cover the cost of both buying a block of land and the construction, or just the construction itself.
Construction loans tend to have higher interest rates than standard residential loans. Borrowers also need to provide more paperwork to the lender to show they have a solid building plan and a contract with a licensed builder.
How do construction loans work?
With a construction loan, your lender considers the total amount you need to borrow in order to pay your builder. Then it breaks down the full amount into separate payments called progress draws.
You receive a payment at the completion of each stage of the construction project rather than all at once. Repayments at this stage are usually interest-only. You don't start paying off the loan principal until the house is complete.
Here's a quick example:
- You're building a $375,000 house on a $125,000 block of land (total cost $500,000).
- You buy the land first and your lender releases $125,000 to cover the cost.
- You are now repaying 25% of the loan according to the loan's interest rate.
- Construction starts and your builder requires $100,000 to cover the foundations.
- Your lender releases a further 20% of your funds to cover this. You're now repaying 45% of the total loan amount, plus interest.
- You continue borrowing instalments until construction progresses. Once completed, you're borrowing (and repaying) the full amount.
The more you borrow or draw down throughout the process, the higher your repayments become. Your full principal and interest payments won't begin until after the handover has taken place and you have received the keys to your new home, meaning you save on interest during the construction process.
Construction loans: 3 experts explain construction finance
What kind of borrowers need a construction loan?
Constructions loans are a suitable mortgage for:
- Owner-occupiers buying land to build their own homes to live in
- Owner-occupiers building homes on land they already own
- Existing home owners looking to make substantial renovations
- Investors looking to build a new investment property
- Owner-builders looking to construct a house themselves
Owner builder mortgages
You can get a construction loan as an owner-builder but it is much harder. The vast majority of banks and lenders will prefer that you choose a licensed builder to construct your home before they extend a construction loan to you.
However, there are some lenders that will allow you to build your own home as an owner-builder. This is ideal if you're a qualified tradesperson or if you have a building licence of your own, but an owner-builder loan isn't suited to the faint of heart.
How to apply for construction finance
Getting a construction loan approved takes a bit more paperwork than other home loans. Here's a rough outline of the process:
- Start by comparing construction loan rates from multiple lenders (see the table above) to get a competitive deal.
- Work out roughly how much you can afford to borrow for your construction loan, based on your income.
- Before applying, make sure you have evidence of your income and expenses, a detailed building plan (with council approval), a contract from a licensed builder and proof that your builder has the necessary builder's insurance.
- When you've found the right loan and gathered your documents, you can submit an application.
- The lender will examine all your documents and conduct a land valuation before (hopefully) approving your loan.
- Once approved, construction can begin and your lender will release funds as needed (according to the agreed-upon building plan).
With construction loans, funds are paid in stages known as progress draws. These stages correspond to the progress of your home's construction. They can vary a little depending on your builder and lender, but generally are as follows:
1. Foundations and footings
- 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.
2. Frame-up and brickwork
- 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.
- At the completion of this stage, the second progress payment will be made.
3. Lock-up stage
- During the lock-up stage of construction, doors and windows will be installed. All exterior walls will also be completed.
- At the end of the lock-up stage, your home will be sealed and protected from the elements.
- Your lender will make the third progress draw payment to your builder. This is one of the most significant drawdowns, often making up 20–35% of the total building funds.
- At the fit-out stage of construction, all fixtures, fittings and appliances will be added.
- 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 installed.
- At the end of this stage, your lender will make the fourth progress payment to your builder.
5. Practical completion
- Your home is almost finished. 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 8 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. After this stage, your construction home loan will also be converted into a traditional home loan.
Construction loan contracts are a bit more complicated than other loan contracts. With any property transaction, you should always have an expert solicitor or conveyancer review any contracts before you sign them.
What clauses are involved with a construction loan?
In some states of Australia you are able to include a subject to finance clause when you sign your contract for your vacant block of land. This type of clause is quite common when purchasing vacant land or even an established home via private treaty sale.
The ability to include a finance clause like this gives you several benefits:
- It helps to protect you against being forced to take out finance that isn't suited to you.
- It allows you to get out of your contractual obligation if your finance application doesn't get approved for whatever reason.
- It removes your block of land from the market while the agent waits to hear about your finance approval.
- It gives you time to obtain your finance.
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