If you’ve never built before, then getting your head around a construction loan can be confusing. Once you understand that these loans work a little differently to conventional loans, it becomes much easier. We’ve broken down what a construction loan is, in detail, so that you won’t lose any sleep over the logistics when it comes time to build.
Simply put, a construction loan is a type of loan designed primarily for people who are building a home. This loan only applies to new properties, so anyone buying an established property is unable to get the same type of funding.
Construction loans are designed to work in conjunction with the building process and require regular payments as completed stages of construction occur. These payments are called ‘progress payments’, which is when the borrower releases some of the funds approved by a lender to the builder.
Most lenders offer construction loans, but not all, so check that your lender provides this type of finance before applying for a loan.
Progress payments when building typically take place in five stages, though some builders may have different schedules, which you should find out before you sign any contract. It’s also important to ask about fees, as most lenders charge you when they make a progress payment – also known as a progressive drawdown.
The main stages of building when progress payments occur are:
When you first apply for a construction loan, your lender will need to see a copy of the building contract. Lenders also request an independent evaluation of the estimated value of the property at the time of completion. This valuation ensures that they are making a sound investment. If satisfied with the figures presented, then your lender will then agree to lend you a specified amount. If this amount does not cover the full loan cost, then you’ll need to pay the shortfall or balance owed using your own funds.
Under new legislation, the short-fall is payable at the time of land settlement. Therefore, you’ll need to make sure you have these funds available or you may jeopardise land settlement.
You must also be aware that any other costs you incur, which were not in the original contract, will need to be covered by you. For example, if at the time of selecting your fittings for the new home, you choose designer items instead of the standard included in the contract, which cost an additional $2,500, you’ll need to pay this expense at the time of completion.
However, there are exceptions to this rule. Some lenders will allow you to increase your loan to cover more substantial expenses, but you’ll typically need to apply at least a month in advance to cover the shortfall.
Before you jump into a construction loan, it’s essential that you find the right product for you and your circumstances and consider interest rates, fees and features, as well as construction terms. By comparing these, and then negotiating with lenders, you’ll get the best possible deal.
Are you thinking of building your own home, but aren’t sure where to start? eChoice’s expert brokers can help you understand the market and simplify the process of applying for a construction loan. We have access to hundreds of products, so we’ll find you a competitive rate.