Erin Delahunty - 1 Feb, 2021
On the surface, buying and building a house seem pretty similar, but they’re different when it comes to the finance side.
To buy an existing property, a conventional mortgage is used, but when building from scratch, a different type of lending product is needed. It’s called a construction loan.
Specifically designed for people building, construction loans are funded in progress payments that cover the cost of each stage of a build. Payments are sent to the builder as each section is completed.
With low interest rates and a several government incentives on offer, there’s been a surge in the number of construction loans being taken out across Australia of late.
Australian Bureau of Statistics (ABS) data shows the value of new owner/occupier home loans rose 0.8% to $17.4 billion in October, a jump of more than 30% year-on-year.
“The value of construction loan commitments has risen by 65.6% since July, which coincides with the June implementation of HomeBuilder in response to Covid-19,” according to ABS’s Head of Finance and Wealth Amanda Seneviratne.
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A construction loan is a loan designed specifically for those who build a home, rather than buy something that’s already built. They’re generally for new properties, but can also be used for renovations.
Construction loans offer progressive drawdown, meaning the lender pays your loan in small chunks – as and when your builder completes a stage – rather than in a lump sum.
Most construction loans are interest-only for the duration of the build too, so while your home is being built, your costs are kept to a minimum. After this time, the loan reverts to principal and interest. Most lenders, such as the big four banks, offer construction loans.
As with any finance option, there are advantages and disadvantages of construction loans.
Building a home is exciting, but before you start, it makes sense to sit down and think carefully about each step. A design checklist is a great way to do this. The Commonwealth Bank offers some great advice about how.
Whether building on land you own or looking to buy land to build on, research is vital. Look at what’s available, the suitability for what you want to build, the nearby infrastructure and the applicable rules and regulations.
It’s important to spend time finding the right builder and architect, if you want to use one. Get recommendations from friends or family, contact the local Master Builders’ Association and get several licensed builders to quote.
Your builder should provide detailed plans and accurate costings for every aspect of the build. Ensure the contract covers everything and agree to a timeline for completion.
Look into “out of contract” items. These are extra improvements which might not form part of the fixed price building contract. They’re restricted to “non-structural” works, like floor and window coverings. Additional improvements like pergolas, landscaping and swimming pools can also be classed as “out of contract”. All these extras need to formally quoted for.
The builder or architect generally handles getting plans approved. Ensure this is done early, as it can take time to get through council and sometimes amendments might be needed.
Next is the application process. Applying for conditional pre-approval is important, as it’ll help give you a good understanding of what you can afford when choosing the design and builder.
One of the key differences between a traditional mortgage and a construction loan is how it’s paid. They’re funded in progress payments that cover the costs for each stage of your build. Payments are sent to the builder as each section is done and signed off.
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Any other costs you incur, which were not in the original contract, will need to be covered by you. For example, if 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 end.
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.
Qualifying for and securing a construction loan is more complex than getting a regular home loan.
Using the plans, a property appraiser will work out the expected value of the property when it’s completed, and from this figure, determine how much money you’ll need to borrow to pay the builder.
If you’re paying a registered builder to build your home, you’ll likely need to provide:
Next up is having the deposit, which can be anywhere from 5 to 25%, depending on the lender. Lenders’ mortgage insurance might also be payable.
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As with any loan, the amount you can borrow for a construction loan depends on a range of factors such as your salary, living expenses, existing equity, whether you’re applying for a joint loan, interest rates and many other factors.
In general, construction loans have a variable rate, with a maximum LVR of 95%. This varies depending on lenders.
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Words by Erin Delahunty
Originally published November 2018. Updated January 2021.
If you’re thinking of building a 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.