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How do construction loans work in Australia?
A construction loan is designed for borrowers who are building or substantially renovating their home instead of buying an established property.
Unlike a traditional home loan (where you borrow funds as a lump sum), a construction loan has a progressive drawdown structure. It’s paid out in stages, where you progressively draw down on the loan throughout the construction process. You’ll only pay interest on the amount you draw down during construction and on the full loan amount when work is completed.
Before construction begins, your builder will prepare a document outlining the total cost of the build and split it into stages (typically five stages) to set up a payment schedule with your lender.
How the repayments work on a construction loan
Repayments during the construction stage are usually interest-only, and you’ll start making principal and interest (P&I) repayments when the build is completed. As a result, your repayments will be lower initially and gradually increase as your construction progresses to completion.
Construction home loans: Top 10 facts to know
1
You can use a construction loan to build a new home, undertake major structural renovations to an existing property, or even demolish and rebuild a house.
2
Construction home loans have higher interest rates than a standard mortgage. This is because of the increased risk of valuing a property that has yet to be built.
3
Lenders will require building contracts and cost estimates of the construction as part of the loan application process.
4
An 'as if complete' valuation will be conducted to estimate the market value of the land and proposed build before your loan can be approved.
5
Some lenders will charge a drawdown fee ($50 - $200) each time you make a progress payment during construction. These fees are usually added to the loan amount.
6
Building loans have a time frame. Most lenders will give you six months to draw on your loan and up to 24 months to complete the construction of your property.
7
Once construction is complete, your loan will revert to a standard owner-occupier home loan or investment property loan with principal & interest repayments.
8
Variable rate construction loans generally come with an offset and redraw facility. You may not be able to use your redraw facility during the construction period.
9
Most lenders require a minimum 5-10% deposit for a home construction loan, although you’ll need a 20% deposit — or loan-to-value ratio (LVR) below 80% — to avoid paying LMI.
10
If you’re buying land to build on, you may need a land loan and a construction loan.
What are the five stages of construction?
Here are the different stages of construction and what they entail:
Foundation
This includes laying the concrete slab, footings, pad and base brickwork.
Frame
This includes installing support structures like frames, internal walls and roof trusses.
Lock-up
This includes finishing the roof, external walls, doors and windows so that the property is lockable.
Fit-out
Plumbing, gutters and electrical (including lights and power points) are installed.
Completion
This includes finishing touches like painting, cabinetry, tiling and lighting.
How to apply for a construction loan
Work with a construction loan broker who can guide you through the building loan application process as it’s slightly different from a regular mortgage application. In addition to all the usual income documentation (e.g. payslips, bank statements, tax returns) you’ll need to provide to prove your serviceability, you’ll also need to submit paperwork relating to your build, including:
- A contract of sale and acceptance for the land portion
- A fixed-price building contract which sets out the cost, specifications and inclusions of the construction
- The builder’s schedule of progress payments required for each stage of the build
- Building plans, including detailed drawings of your home & measurements
- Development applications & council approved plans
After you submit your paperwork, the lender may grant you pre-approval. In the meantime, they will conduct a ‘tentative on completion’ valuation to confirm the projected value of your new home, and your predicted available equity and construction loan LVR.
If you meet all the lending requirements and there are no unusual circumstances, you may be granted unconditional approval. Your lender will send you a loan offer letter outlining the terms and conditions of your home construction loan. Discuss the loan offer with your conveyancer or solicitor before you sign it.