If you are looking to build your new home rather than buy an existing property, you need a different type of home loan known as a construction loan. A construction loan can also suit you if you are making major renovations to your existing home or to a property you have bought but which needs a bit (or a lot) of work before you call it home.
Construction Home Loan Offer
Greater Bank Great Rate Home Loan - Construction Loan (Owner Occupier, P&I)
Construction Home Loan Offer
The Great Rate Home Loan - Construction Loan (Owner Occupier, P&I) lets you cover the costs of constructing your own home. Get a low interest rate with no application fee or ongoing fees and borrow up to 95% LVR.
A construction loan is a specific type of mortgage designed for people wanting to build a new home. Depending on the way a construction loan is set up, you may be able to purchase your vacant block of land first and then arrange to build on the land within a specified timeframe.
Construction loans aren't set up in quite the same way as a regular mortgage. Instead, the lender considers the total amount you need to borrow in order to pay your builder, and then breaks down the full amount into separate payments called progress draws. These are percentages of the total building contract amount paid out of your mortgage funds to the builder throughout the construction process.
While progress draws are being made, the majority of lenders will only expect you to pay the interest due on the amounts that have been drawn. 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 give their definitions of these loans
Owner builder mortgages
An owner builder mortgage is designed for those people who wish to build their own home without the help of a licensed builder. As banks and lenders use the property as security for your mortgage, many of them consider owner builder mortgages to be high risk. For this reason, many banks and lenders will not accept applications for these types of home loans.
Additionally, those lenders that do offer owner builder mortgages will usually limit the loan amount to 60% of the total land value and construction cost. The lender will take into account the value of the vacant land as part of the valuation total. However, you should note that the actual completed value of the home is rarely taken into account when factoring in the value of the security property with owner builders. Instead, the lender will look closely at the quotes provided to form the estimated cost of materials and labour required to complete the construction.
Who needs a construction loan?
Construction loans are suitable for any borrower intending to build a new home on a vacant block of land. This includes buying a house and land package from a licensed builder, or conducting major renovations to an existing home, such as adding new rooms.
Property developers for small scale developments may also use construction loans, but these might only be available if you're building under a certain number of properties. If you're building a larger amount of properties (usually over four) most lenders will consider this to be larger-scale development, which will require commercial finance instead.
What you need to consider about construction loans
Due to the inherent risks involved for the lender, construction home loans are normally only offered to borrowers who have very good credit histories. The eligibility criteria is much more stringent for construction home loan applicants than it is for borrowers applying for a more traditional home loan. The initial down payment that is required is usually quite significant, especially if the building lot is not of great value without a building on it. Most lenders will want at least 20% of the total cost put down as a deposit.
But it's not just the cost you need to consider before choosing to build. There are a number of other factors you should be aware of when choosing a construction home loan:
Do I need to buy a house and land package to get a construction loan?
You don't technically need to buy a house and land package from one builder or developer to get a construction loan. You may have already purchased a vacant block of land earlier using a regular home loan. It's only when you sign a building contract with your licensed builder that you'll need a construction loan. Keep in mind that you will end up with two separate mortgages this way.
Do I have to use a licensed builder to construct my home?
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 for 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 license of your own, but an owner builder loan isn't suited to the faint of heart.
What clauses are involved with a construction loan?
In some states of Australia you are able to include a 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 (not at auction), where you're able to insert a clause that says "Subject to Finance".
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.
You may also be able to include specific dates and other information that is relevant to your clause. For example, you can add that your clause is subject to finance being approved with a specific lender for no more than a specific interest rate and that your finance approval needs to be received by a specific date. Remember, in this instance your finance approval is the full formal approval, or unconditional approval from your bank.
The primary reason for adding specific information like this is to protect you against having to accept finance that isn't right for you or your situation. So, if you've already received a pre-approval from your lender and you already know your interest rate, you can enter this information into your clause.
For example: This contract is subject to obtaining finance with Westpac at an interest rate no higher than 6.11% on or before 12th December.
If your finance clause is written this way, you have some backup in case your bank suddenly decides to decline your mortgage application at the last minute. After all, if you've simply written "Subject to Finance" and nothing else, you might suddenly find that the vendor can insist you accept any finance at ridiculous interest rates just to comply with the contract.
What if a building contract changes?
There are some cases where a lender will make a construction loan more expensive. This is due to how the contract price might go up after you get an amendment on your home prepared. This can especially be difficult because the builder will end up having to reassess the value of the loan from the top. However, you can do a few things in order to keep this from being a problem down the road.
Get your building contract completed and finalised before sending it to your lender.
Pay for any new changes to your construction with your own money. You could also ask your builder to reimburse you in the event that you got any discounts out of something.
Consult your lender if the changes are massive. You might need to wait a month for the lender to review the loan again.
Be sure to simplify your changes. This is so it will be easier for the bank to make changes and to keep from being delayed in the process.
How to choose a construction loan
Just like a regular home loan, the way you compare a construction loan will have an impact on the value you get out of it. Here's what you should compare:
Interest rates. You'll only be paying interest during the construction period, meaning the interest rate you receive will have an important bearing on the size of your repayments. Keep in mind that the advertised rate doesn't take into account the fees you will pay for the loan, so be sure to also look at the comparison rate, as this will have an impact on this.
Fees. Some construction loans will have extra fees which they'll charge to cover the costs of having a valuer check your property after each stage of the building is completed. Some home loans can also charge extra administration fees for construction loans, so you may need to factor this into the total cost of your home loan. These fees are in addition to regular upfront fees such as application costs, valuation fees and more.
Features. During the construction phase most features of your home loan will be unavailable, such as redraw and the ability to make additional repayments (this of course will depend on the particular loan), but it still pays to know what features you'll be able to use once the construction phase ends. Find out what features you want out of your home loan and then ensure you search for these during your comparison.
Construction terms. You'll want to confirm what construction terms your loan will offer, including how long you can build for using the loan and the process for drawing down and accessing funds.
Understanding the 5 steps of a construction loan
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.
Nevertheless, at the end of this final drawdown, you'll be able to move into your new home.
FAQs about construction loans
Most construction loans give you up to two years to finish the construction of a new home. If you’ve purchased your vacant block of land as part of your construction loan, the time frame commences after your land purchase has settled.
While your full mortgage amount might be approved to cover the cost of the construction, the progress payments are divided into usually five portions. These are broken down to be paid to the builder after the completion of various stages of the construction. The exact proportion of your contract amount to be paid with each progress payment will be detailed in your building contract.
During the construction process, your bank will pay your builder for each individual stage of work completed after it’s been done. Each individual payment is known as a ‘draw down’, or a progress payment.
There are times when you may want to include quotes from external contractors who aren’t with your builder as part of your total mortgage. This might include quotes for air conditioning, floor coverings, driveways or pergolas to be added. Some banks will allow you to add individual quotes to your building pack or bank pack that your builder gave you, which lets you include those things in your mortgage amount. The progress draw payments remain the same to your builder, but the payment for those external quotes won’t happen until after the builder has been paid first and your house is at practical completion stage.
Most builders try to offer ‘Fixed Price’ contracts. While the cost of your new home construction won’t change after this has been fixed for you, always be very wary of ‘variations’ added to your final costs by the builder. These can include changes in the footings/foundation price after soil testing has been conducted.
If your contract includes a ‘TBA’ or ‘NC’ item listed anywhere, ask for verification about this. These are the builder’s way of saying that your house price might be fixed, but there might be things that can change in cost that they won’t guarantee.
Price increases can also include any upgrades you may have made during your colour selections process. This is when you arrive at various suppliers to choose your tiles, paint, bricks, roofing and other items that go into your house. Your building contract will include an allocation to cover these things, but if you spend more than you intended, your costs will go up.
Most banks are quite understanding about this and will expect that all those final variations have been received by the time your finance approval is underway. Any changes in pricing after this time may require you to alert the bank to account for the extra, or they’ll need to be paid by you.
Most banks and lenders will let you borrow up to 95% of the value of the land plus the construction costs. Note that this doesn’t say ‘95% of market value’, as it would if you were buying an established home. Instead, banks use a ‘To Be Erected’, or TBE valuation to determine what percentage of your costs you can borrow.
This means the bank will use the actual market value of your land, or the purchase price shown on the purchase contract, whichever is lower. Then they’ll add the exact cost of your construction to your land value to arrive at a TBE valuation amount.
This is not the same as the market value of your property once the construction has been completed. If you’re careful with your spending, it could be possible to pay less money constructing your home than it is actually worth in market value once it’s completed. If this is the case, it is very possible to have your newly built home re-valued three months after completion to maximise your equity. This is ideal if you intend to refinance after construction is finished to help pay for finishing touches to your home.
Yes, of course. In fact, almost all construction loans are set to interest-only payments during the progress draws period. Only after the construction is complete and the final draw down payment has been made will your loan revert to a full Principal and Interest payment, unless you specifically request for it to stay on Interest-Only payments.
Most banks will allow you to make extra payments off your mortgage while your loan is still in the progress draws stage. Some banks will even let you link a 100% offset account to your mortgage account while it’s still being drawn down. This helps you get ahead on your mortgage while the balance is still low and reduces how much interest you’ll pay overall. Always check with your bank that they’ll allow this.
Building your own home can mean you get everything exactly the way you want it and with a construction loan you remain in control of the building process at every stage.
Marc Terrano is a lead publisher and growth marketer at Finder. He has previously worked at Finder as a publisher for frequent flyer points and home loans, and as a writer, podcast host and content marketer. Marc has a Bachelor of Communications (Journalism) from the University of Technology Sydney. He’s passionate about creating honest and simple reviews and comparisons to help everyone get value for money.
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