How do construction loans work?

How do construction loans work?

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.

construction loan

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What’s a construction loan?

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.

What is my mortgage repayment?



What are the advantages and disadvantages of construction loans?

As with any finance option, there are advantages and disadvantages of construction loans.

The main benefit is they minimise your monthly repayments, as you only pay interest on the amount drawn down, not the total amount. On the negative side, the deposit required for a construction loan can be higher than for a regular mortgage, but it depends.


  • Financial protection: By making progress payments, rather than paying a lump-sum up-front, you cover yourself against financial loss. You also ensure the work is completed to a satisfactory standard.
  • Reduced interest: If you’re only making partial payments, you’ll only incur interest on the amount you’ve drawn down.
  • Additional payments: Most lenders allow you to make additional payments into your construction loan. This reduces your balance and means you may pay less interest.


  • Bigger deposit: Construction loans typically have a higher loan-to-value-ratio (LVR). So, you’ll need to ensure you have an adequate deposit to cover additional costs.
  • Progress payments: Typically, your lender will need to assess work carried out before they’ll release a progress payment. This process can be time-consuming and frustrating.
  • Higher rates: Construction loans often attract higher interest rates, so it’s important to do your homework before signing a contract, so you don’t end up paying more than you should.
  • Paperwork: As a construction loan is more complex than a regular loan, the paperwork can be arduous and involve a lot of back and forward between you, the lender and your builder.

How to create a design checklist for your build

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.

1. Do your research

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.

2. Choose a builder and/or architect

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.

3. Draw up plans and get a fixed price building contract

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.

4. Understand “out of contract” items

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.

5. Have your plans approved

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.

6. Apply for a construction loan

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.

How are payments deducted with a construction loan?

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.

Construction loan payment stages

Progress payments are typically paid in five stages:
  1. Slab or base down – The first drawdown covers the foundation. This generally includes levelling the ground and installing plumbing and waterproofing. It represents approximately 15-20% of funds.
  2. Frame up – The next drawdown is for the framing. This generally includes the construction of trusses and windows, roofing and partial brickwork. It represents approximately 20%.
  3. Lockup – Lockup is when the building is lockable to the outside world. This drawdown generally includes brickwork and external doors, putting up external walls and insulation and installing windows and doors. It represents approximately 20 per cent.
  4. Fixing or fit out – This stage covers the installation of internal fittings and fixtures and items such as internal cladding, tiles and partial installation of shelves, cupboards and cabinets. It also covers plumbing and electrical. It represents approximately 30 per cent.
  5. Completion – This payment covers the finishing of walls and ceilings, as well as painting, electrical appliance fitting and the final clean and presentation. It represents approximately 10 per cent.

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Does the construction loan cover contract changes?

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.

How do you qualify for a home construction loan?

Qualifying for and securing a construction loan is more complex than getting a regular home loan.

As well as disclosing your income, monthly expenses and assets, you’ll need to present the lender with your building plans and your builder’s credentials, as they will be assessed.

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:

  • A copy of signed industry-standard fixed-price contract and an acceptable progress payment schedule
  • A copy of plans (including measurements), specifications (materials and inclusions etc.) and permits
  • A receipt for any deposit paid to the builder or suppliers
  • A copy of the builder’s licence
  • The builder’s bank account details for direct credit of progress payments
  • Copies of insurance policies.

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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How much can you borrow on a home construction loan?

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.

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