At some point in our new home or investment journey, most of us will likely have the need to borrow money from a bank or financier. Whilst most of us are familiar with residential home loans, many people are unaware that construction loans – money borrowed to build a home – even exist.
Thankfully the process for borrowing money to build is relatively straightforward, albeit slightly different to a regular home loan. In this blog we outline the important facts about construction loans and run through a case study on financing a home & land package. We also list a few key questions to take back to your lender when you’re borrowing money to build.
How do construction loans work?
To apply for a construction loan, you will need a building contract and house plans to present to your lender. Much like a home loan, the lender will assess your creditworthiness as well as perform a valuation before approving a loan. Again, like a home loan, the approved construction loan will most likely not be for the full contract amount but rather for a certain percentage, known as the loan-to-value ratio (LVR).
Once approval is granted, the construction loan will involve the following processes over the building timeline:
- Interest payments
- Fixed Construction Period
- Principal & Interest Reversion
Drawdowns are staged payments that are made once specific building milestones are complete. Each drawdown is calculated as a percentage of the overall build cost and drawdown payments will follow a drawdown schedule specified in the building contract. Typically your lender will engage a quantity surveyor to ensure the building works are complete before releasing each drawdown payment.
The table below gives an outline of a typical HIA Contract drawdown schedule. For this example, the total build cost is $250,000 with loan-to-value ratio of 80%.
- Deposit – 5% – $12,500 – Purchaser Pays
- Base Stage – 15% – $37,500 – Purchaser Pays
- Frame Stage – 20% – $50,000 – Lender Pays
- Enclosed Stage – 25% – $62,500 – Lender Pays
- Fixing Stage – 20% – $50,000 – Lender Pays
- Completion – 15% – $37,500 – Lender Pays
|Drawdown Stage||% due||Amount||Paid By|
Contributions – When Do I Pay, When Does The Lender Pay?
As with almost any loan, you will be required to pay the difference between the contract price and loan amount before the lender will release any loaned funds. These are known as cash contributions, and depending on your LVR, you will pay the 5% build deposit and contribute to the base stage payment.
The final drawdown will occur the day you receive the keys, after which your loan will be fully drawn. You can move in after handover is complete.
During the build process you will be required to make interest payments. As the loan is progressively drawn down, you will only pay interest on the outstanding amount, similar to a line of credit.
Fixed Construction Period
Most lenders will place a restriction on the time to complete construction – ranging from 6 to 24 months.
Principal & Interest Reversion
For a certain period of time (usually 12 months), a construction loan will require interest only repayments. However, after this time the loan will revert to a standard principal and interest loan.
Case Study – financing a home & land package
Financing a home and land package is different to purchasing an existing home in that it consists of two contracts, each with a separate corresponding loan.
- The Land Loan – the land contract is used to obtain a loan to buy the land. The full loan amount is drawn at settlement. Interest is payable on the full loan amount.
- The Construction Loan – the build contract is used to obtain a construction loan. This loan is progressively drawn down via staged payments in line with building milestones. Interest is payable on the withdrawn amount.
Following completion, you may opt to consolidate or refinance your loans into a single fixed term home loan – talk to your lender to find out more.
Concessions and Grants to help finance your home & land package
When purchasing a home and land package, stamp duty is only payable on the land, offering a considerable saving over a comparable existing home. Stamp duty concessions may be available to first home buyers or owner occupiers, find out more here. The Great Start Grant is available to eligible first home buyers. Check out our FAQs to find out more.
A Quick Note on Avoiding Surprise Costs during your Building Journey
It is extremely important to ensure you are offered a fixed price, full turnkey building contract with all hidden costs of building accounted for. Unfortunately, many builders use inaccurate allowances and variation clauses to sting clients with extra costs, after they have committed to a contract. These have to be paid for out of your own pocket or resubmitted for finance, delaying your build.
Questions for your lender
Use the following as a guidelines for the questions to take to your lender:
- I am looking to build – what construction loan facilities do you have available?
- How much cash will I need to contribute over the course of my build and when are these payments due?
- What are the drawdown amounts? What are the progress fees associated with each drawdown?
- Is there a fixed construction period?
- Can you provide a schedule of the expected repayments for my construction loan? Is it possible to have these capitalised into the loan?
- Am I eligible for any building grants or concessions and how can I use these to help finance my build?
A construction finance broker is a vital member of your building team, combining intimate knowledge of both finance and building. Contact us if you would like our recommended list of reputable construction specialist brokers.
What is a construction loan?
Construction loans: what to be aware of?
This article is general in nature and should not be relied upon for individual decision making purposes. For specific advice regarding your individual circumstances, contact accredited professionals before making any purchasing decisions.
This article is original content produced by Built Easy. For re-purposing or reproduction right, please contact us.