In Australia, you’re spoiled for choice when it comes to construction loans.

But you might find yourself asking, what exactly is a construction loan and is it for me? This article will break down all that you need to know so that when you’re done, you’ll be so au fait with this form of credit you’ll be able to offer others advice on it!

What is a construction loan?

Simply put, this loan is a type of home loan introduced into the market for individuals that might be looking to build a home as opposed to purchasing an already built home. The structure of the loan is very different and one must take cognisance of these differences, as it will make all the difference when you’re preparing for your new home!

Construction loans can be explained as a drawdown loan. This simply means that you increase the borrowing amount as it’s required when payments are due. This will fall in line with the progress of the construction.

How much can you borrow for construction?

Well, that depends on what the forecasted value of the property at the time of completion of the build. A number of factors will be taken into consideration to decide this figure which includes the area and property size, as well as living area on the property, only to mention a few.

As with most business and personal loans, we know that the first few years, it feels like all we’re ever paying is interest because the outstanding balance never budges! With construction loans, you’ll find that you’re only paying back interest for the first year. Thereafter the loan repayments will reflect the standard principal plus interest amount on the account.

How do progress payments work?

Firstly, the loan needs to be approved. Once that is confirmed and all in order, then it’s just a matter of making payments monthly during the progress of the build until completion. This progress can be broken down into 5 different phases:

  1. Slab Down: This figure assists in the laying of the foundation of your new property. Levelling of the earth is covered in this phase, as well as any plumbing and waterproofing.
  2. Frame Phase: This figure will ensure coverage of the frame of your property. Partial brickwork is included, as well as any roofing, including trusses and windows.
  3. Lockup: This figure covers your walls (now it’s starting to become something!) It also gets your windows and doors fitted which explains the phase, “lock up” phase, as it translates to being able to lock up and go!
  4. Fitout: This figure gets the internal fittings and finishes done to the property. It’ll cover plasterboards and cupboard fittings. This phase also caters to the electrical and gutters of the property.
  5. Completion Phase: This figure pays for the builders and any last-minute touches and fixes required.

As discussed, the loan is drawn down, and given that the build is broken down into different phases, the repayments are calculated based on monies that have been used at each point, and not based on the total loan amount. Here’s a little fact – as soon as the loan is fully drawn down, one can make additional repayments and apply to redraw them.

Could I still apply for a standard home loan instead?

The answer is yes. If it so happens that you have sufficient funds in an already existing home loan, then you would certainly be able to use that amount without using the new property to build security.

Based on the premise that you do have sufficient funds in a current home loan, you could redraw them for your construction loan, either all in one go or progressively as with the construction loan. There is an advantage to redrawing and that is that you’re able to afford the construction costs when they are due at each phase. However, a disadvantage that one could encounter by drawing from a home loan means you’re in for interest payments from the outset. 

Where rates are concerned with this loan type, they are higher initially, but once the build is complete, you can very easily refinance it into a permanent bond and potentially receive a much lower rate!

How do I apply for a construction loan?

The process can be a smooth one if you go about it the right way. But that’s why you’re reading this portion of the article, aren’t you?! It’s different from the standard home loan approval process, and you’ll start off by presenting the lending company with the plans for your new property. At this point, a property appraiser will assess the plans and property and establish a property value for the date of completion.

The reason behind why this is done at this stage is due to the banks needing that figure in order to establish the correct loan amount that can be approved for borrowing. Following this process, you’ll be required to make a deposit and this doubles as security during the stage of construction. Feel free to give a large deposit – as with all lenders for any loan in fact, the higher the deposit – the better the rates, the better the trust!

Each phase calls for a sign off of the lending company and the drawdown request form will need to be signed as well.

Mortgages that are owner-built

Another consideration when going through the concept of construction loans is the one where the owner is also the builder! Sound strange? Well, it’s not uncommon! There are homeowners out there that require a specific type of loan tailored for those who intend to build the house themselves without the help of a professional builder.

Lending companies have their reservations when it comes to these loan applications because usually, they are using the property as security, where in this instance you’ll be a high risk if you’re building the property yourself. That said, they will approve the loan, but with a limit in place and a higher deposit requirement.