A low doc loan makes it easier for self-employed home loan applicants to borrow money without providing proof of income. If you want finance to build a new home, you'll need a low doc construction loan. Here's how its works and how to boost your chances of being approved for a loan.
What is a low doc construction loan?
A construction loan is a mortgage designed for borrowers who want funds to build a new home. It can be used to fund major home renovation projects and knockdown-rebuilds.
Unlike a regular home loan that allows you to borrow a large amount of funds straight away, a construction loan is provided in staggered payments.
Your lender will approve an overall amount (say, $500,000) based on how much the builder has quoted you to construct your house. That amount is then broken down into smaller individual payments, referred to as progress draws, which are paid directly to your builder by the bank in instalments at agreed times.
While construction loans are available for ordinary borrowers, low doc construction loans are designed for self-employed people and others who can't provide the usual proof of income.
You can use this type of loan for the construction of:
- Freestanding house
- Multiple units on 1 title
- A granny flat
- Major structural renovations
What documents do you need to apply for a low doc construction loan?
When you apply for a low doc construction loan, your lender will require full details of your construction project in addition to the normal criteria of a low doc home loan.
These may include the following documents:
- Builder's insurance policy
- Construction certificate (NSW) or building permit (VIC) or similar for your state or territory
- Copy of your building contract or construction tender
- Copy of the stamped council approved plans (or draft plans)
- List of specifications or schedule of finishes
- Public risk insurance
Lenders can use stricter criteria for borrowers applying for low doc construction loans. The interest rates they charge may also be higher than normal residential loans. This is because they are taking on a bigger risk by lending you the money than they are with a regular PAYG income earner buying an established house.
An option for borrowers seeking a low doc construction loan is to speak to a mortgage broker. A broker will know which lenders may accept a borrower's application and what requirements this will come with. Brokers don't usually charge a fee, instead receiving a commission from the borrower's lender.
Pros and cons of low doc construction loans
- Minimal documentation required. Thanks to their relaxed lending criteria, low doc loans make it possible for self-employed borrowers to get the funding they need to build a home.
- Pay interest only when you spend. While your home is being built, you only pay interest on the progress draws you have made to pay your builder. Once construction is complete and you've moved into your new home, you then start making principal and interest repayments towards the full loan amount.
- Wide range of options. Low doc loans are a common option from an increasing range of lenders, giving you the freedom of choice when looking for a low doc construction loan.
- Interest-only repayments (temporarily). The ability to make interest-only repayments during the construction process helps you stay in control of your finances during this stressful period.
- Higher interest rates. Low doc construction loans tend to attract higher interest rates than other types of home loan, to compensate for the higher risks.
- Higher LVR requirements. As lenders classify low doc borrowers as higher-risk borrowers, low doc loans tend to attract lower LVRs (loan to valuation ratios) than standard loans. The most you will likely borrow with a low doc construction loan is 80% LVR.
- More fees. Low doc loans also tend to attract higher fees than normal loans, especially on upfront costs. Application, establishment, valuation and legal fees are typically more expensive on low doc loans.
- Construction timeframe. Many construction loans come with a timeframe within which your home must be completed, for example, 12 months. If your project is delayed, you may need to liaise with your bank to manage the delays.
How to apply for a low doc construction loan
Applying for a low doc loan is a little easier than applying for a full doc home loan. There's less paperwork to gather and providing proof of income is simpler.
Still, you can improve your chances of approval if you know exactly what's required upfront.
While lending criteria vary between lenders, you will need to supply the following to apply for a low doc construction loan:
- Personal details. You'll need to provide your full name and contact details.
- Loan amount. Specify the amount you wish to borrow for your construction loan.
- The purpose of the loan. For example, will you be buying a house-and-land construction package or paying for construction only?
- A signed income declaration. This will be used to determine your capacity to make repayments.
- Your Australian business number (ABN). Lenders will use this to confirm that you are self-employed and check how long you have been self-employed for.
- Business activity statement (BAS). You will need to provide a BAS or a letter from your accountant detailing your business activities.
- A contract. A signed fixed price Housing Industry Association/Master Builders Association building contract will be required. This will include project specifications and costs.
- Council-approved building plans. These may not be required when you first apply for a loan. However, you may need to supply these before you can draw down from the loan.
- A copy of the builder's licence. The lender will need to be sure that you are using a licensed builder for the construction project.
- Insurance. You'll need to make sure your builder has adequate insurance cover in place.
- Extra quotes. Quotes will need to be provided for any extra work excluded in the building contract, for example, driveway construction or landscape gardening.
Depending on where you live, you may also access a stamp duty concession or grant for new home builders from your state or territory government. Contact the revenue office in your state or territory for more details.
Our hypothetical example Tom is a freelance IT consultant who runs a computing business from his home office. He purchased a block of land 3 years ago and is now ready to start building his dream home. With a deposit of $100,000 saved up, Tom wants to borrow $400,000 to finance his home's construction.
Because he is self-employed and his income fluctuates from month to month, he's unable to qualify for a regular construction loan from his bank.
Instead, Tom applies for a low doc construction loan from his bank. Thanks to his deposit, Tom can borrow up to $500,000 and he doesn't need to supply payslips or employment details as part of the loan application process.
In terms of proof of income, all he has to supply is a signed income declaration. The loan is set up so that he only has to pay interest on his progress draws during the expensive construction process.
With the finance he needs, Tom is able to oversee the construction of his dream home within 6 months. He then moves in and starts paying off the principal and interest on his low doc construction loan.
* This is a fictional, but realistic, example.
Traps to avoid with low doc construction loans
Just as with any other mortgage product, there are a few key traps to be wary of when taking out a low doc construction loan:
- Borrowing too much. It's essential that you work out how much you can afford to repay before you take out a loan. Take your income, debt and other expenses into account when calculating your repayment ability.
- Not reading the fine print. As mentioned above, low doc construction loans tend to feature lower LVRs, higher interest rates and higher fees than normal construction loans. It's important that you're aware of all of the costs associated with a loan before you decide whether it's right for you.
- Not comparing your options. Unless you shop around for the best deal, there's no way you can be sure you're getting the right low doc construction loan for your needs. Compare the features and costs of a number of loans — for example, how big a fee will you need to pay every time you draw down on your loan amount? Can you make interest-only repayments during the construction process? Answering these questions will help you narrow your choices down to the best loan.
- Not getting help. Choosing an ordinary home loan can be daunting and overwhelming, but choosing a niche product like a low doc construction loan can be even more confusing. If you're having trouble making sense of all the lending jargon and comparing loans, ask a mortgage broker for advice tailored to your situation.