Construction loans and owner builder mortgages
A construction loan could help you unlock access to your dream home. Learn how construction loans work, and how to pay less interest while you build your new property.
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If you are looking to build your new home or investment property, you need a different type of home loan known as a construction loan. A construction loan may also suit you if you are making major renovations to an existing property. They are similar to regular loans, with a few key differences, as outlined below.
variable rate comparison rate The Greater Bank Great Rate Home Loan - Construction Loan (Owner Occupier, P&I) offers a competitive variable interest rate and has a construction option for borrowers building their homes.
Construction Home Loan Offer
The Greater Bank Great Rate Home Loan - Construction Loan (Owner Occupier, P&I) offers a competitive variable interest rate and has a construction option for borrowers building their homes.
Compare home loans with construction options
*Note that while the loans below offer construction options, this may change the rates or fees displayed below.
What is a construction loan?
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 a vacant block of land first and then arrange to build on the land within a specified timeframe.
Construction loans aren't set up 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. For instance:
- The total house and land package value is $500,000
- The land purchase price is $125,000
- Your lender allows you to draw down $125,000 (25% of the total loan)
- Therefore, you are now making repayments based on 25% of the total loan value
- When construction of the property is due to commence, you builder requests $100,000
- Your lender releases another draw down of $100,000 (20% of the total loan)
- You have now drawn down 45% of the total loan
- Therefore, you are now making repayments based on 45% of the total loan value
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 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.
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