News - 27 Oct, 2020

Construction home loan rates cut

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Lenders are cutting interest rates on construction loans in a possible attempt to lure applicants of the Morrison government’s $25,000 HomeBuilder grant.

Announced in June this year, the HomeBuilder scheme is a $25,000 grant for eligible owner-occupiers to use towards building a new home or substantially renovating an existing home. It was launched to help the residential construction sector which was expected to slow down over the second half of 2020 as new contracts became scarce.

“… there are still some sectors of the economy that are going to do it tough for a while yet. And the housing sector is one of those sectors,” said Treasurer Josh Frydenberg at its 4 June announcement in Googong, NSW.

“It’s worth $100 billion dollars a year to the Australian economy, around 5 per cent of GDP, more than a million people are employed in the construction industry more generally across Australia. So, today’s announcement is designed to get our tradies back to work.”

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As is the theme of the year, interest rates are at record lows across loan products, and construction loans are no exception.

Savings.com reported Qudos bank have cut their construction loan by 50 basis points to 2.89% p.a. Freedom Lend made a smaller cut to their variable rate construction loan, dropping it by 3 basis points to 2.68% p.a.

The construction sector is struggling from the impacts of the coronavirus, including lockdown conditions in Victoria and border closures elsewhere.

The Australian Industry Group/Housing Industry Association (HIA) revealed its Australian Performance of Construction Index dropped by 4.8 points to 37.9 points in August (seasonally adjusted).

Index results below 50 points indicate contraction in the industry, with lower results representing a faster rate of contraction.

The drop followed a pause in July, with the August drop coinciding with stage four restrictions brought on by Victoria’s second wave.

New modelling from the National Housing Finance and Investment Corporation has also predicted trouble ahead for the construction sector, reporting that 230,000 fewer dwellings will need to be built as border closures and recession cause population growth and immigration to fall.

The research showed that over the next three years, COVID-19 could cut underlying demand for new private houses and apartments in Australia by between 129,000 and 232,000.

“Large falls in underlying dwelling demand are already putting upward pressure on vacancy rates and downward pressure on rents, particularly in some inner-city areas,” the report said.

“If sustained, this could cause a contraction in construction activity that would add to the recessionary forces impacting the economy.”

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Should there be a HomeBuilder scheme extension?

So far, the HomeBuilder grant has had a positive impact on the construction sector, though industry leaders are calling for the scheme to be extended.

Master Builders Australia would like to see the Federal Government extend its HomeBuilder scheme at the 6 October Federal Budget.

“We want to see the Federal Government extend what has been the most effective government stimulus measure in a decade for an additional 12 months,” Denita Wawn, CEO of Master Builders Australia said.

“Despite the undeniable success of HomeBuilder so far, we have downgraded our forecast for the housing sector by 25% for 2020/21 so that we are now predicting a 27% fall in homebuilding activity compared to 2019/20.

“This will be calamitous for many of the nearly 370,000 home building businesses that are vital to local economies and communities throughout Australia unless the Government steps in with extension of HomeBuilder and other stimulus measures.”

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Although agreed to have provided the stimulus to the economy, the effectiveness of HomeBuilder has been brought into question due to its eligibility criteria and initially delayed application process, which was given to the states to organise.

While the application process is now open in all jurisdictions, in August the Treasury revealed to the COVID-19 select committee that only 247 applications had been received, though some states had been yet to report numbers.

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“As of 7 August, South Australia had received 157 applications, Tasmania had received, by the 4 August, 90 applications, and those are [all] the applications that have been received to date,” Jenny Wilkinson, Treasury’s fiscal group deputy secretary, told the committee.

However, despite evidence of a slow initial take-up of the scheme, the HIA have reported a 61.3% quarter-on-quarter increase in new home sales in the three months to August 2020.

“All jurisdictions have seen sales surge in the three months since the announcement of HomeBuilder in June,” said the HIA report.

“This surge followed three of the worst monthly sales volumes on record.”

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What is a construction loan?

A construction loan can be used to help finance major renovations, a knock-down rebuild or to build a new house. They are usually intended for owner-occupied properties or investments and are generally not suited for dwellings intended to be sold right away.

Often operating on an ‘interest only’ model during the construction period, before reverting to ‘Principal and Interest’ for the remainder of the loan, construction loans usually have an outlined timeline for the completion of the build and applicants only pay interest on the amount drawn. This means construction loan holders don’t have to draw the total loan amount all at once.

How does a construction loan differ from a home loan?

While a home loan will generally offer a large, upfront payment – that is directly used towards to payment of a house – a construction loan offers payments in small increments in line with the progress of the build.

Construction loans also generally operate on an interest-only model during the build phase, meaning the loan holder only needs to make interest payments on the amount drawn. They are usually reverted to Principal and Interest at the completion of the build when all money has been drawn, becoming more similar to a regular home loan.

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Who should consider a construction loan?

A construction loan is designed for those who are completing a build or renovation and need access to funds throughout the process. It is not the same as a regular home loan and should not be considered by anyone buying an established home, unless renovations or a knock-down rebuild are planned.

For those who already own property, an equity home loan could be another option. This loan type uses the equity you have already gained to top-up your home loan. Unlike a construction loan, with this loan type the funds would become available all at once, meaning you would begin paying interest on the total loan amount immediately.

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What are the pros and cons of a construction loan?

Pros:

  • Interest-only during construction.
  • Freedom to build or renovate house to own specifications.

Cons:

  • High monthly payments at the completion of construction (when loan reverted to Principal and Interest after only making Interest payments during the build).
  • Minimum standards to qualify can be high due to flexibility of the loan.

Can I get conditional approval for a construction loan?

Yes, like any other home loan construction loans are eligible for conditional pre-approval. This allows applicants to plan for construction with piece-of-mind of the funding they could be eligible for.

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Words by Kathryn Lee

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