A construction loan might be more complicated than you think – it’s not just a straightforward lump sum of money from the bank like a standard home loan.
Construction loans are structured using a progressive drawdown payment structure as this helps in terms of planning and budgeting via a fixed price building contract.
We’ve created this guide to demonstrate how a construction loan differs from a standard home loan and how it could be of service to you.
What Can You Use Construction Loans For?
Because of its entirely different loan structure to a home loan or personal loan, a construction loan is made to build an entirely new home from the ground up or a major renovation on an existing property (structural renovations).
A construction loan is structured around the different stages that take place during the construction process.
How Do Construction Loans Work?
The payment process attached to this type of loan differs from other renovation home loans because construction loans have a progressive drawdown payment structure.
This means that instead of receiving the total loan amount when approved, you receive multiple home loan amounts in the form of progress payments that get paid out once you reach each stage of the construction process.
Take note that the progress payments are only paid out after each stage is completed.
You’ll need to provide your mortgage broker an invoice provided by your builder at the end of each stage so that your lender can release the progress payment to your builder. It’s not uncommon for lenders to check up on the process before releasing the progress payment.
How Much of a Deposit Is Required?
Most lenders require a minimum of 5% deposit of the total building cost. Lenders would like you to use your own funds before the bank will allow you to use their funds.
How Do You Pay Interest on a Construction Loan?
Construction loans are interest-only payments, the land loan itself can be interest-only or principal and interest repayments. At the end of the house’s construction period, the loan balance will revert to a principal and interest loan if your loan is only approved for interest-only during the construction period.
In a construction loan, you will only pay interest on money you have used.
So, if you have taken out a construction loan of $500,000 but have only paid your builders $100,000 so far, you will only be paying interest on $100,000 until you receive your next progress payment.
How Are Progress Payments Scheduled?
For your flexibility and convenience, construction loans have a progress payment schedule of five stages.
- Stage 1: Slab down or base
- Stage 2: Frame
- Stage 3: Lock-up
- Stage 4: Fixing
- Stage 5: Completion
If you are not building from scratch but have chosen to renovate substantially, the stages will be adjusted accordingly.
Stage 1: Slab Down or Base
Your first progress payment is to pay for the building costs of the base of your home.
This process includes:
- levelling the ground,
- laying the foundation slab,
- waterproofing the foundation, and
- installing the plumbing.
This construction period can take around two weeks to complete, and you can expect it to amount to between 10%-20% of your construction loan.
Stage 2: Frame
The second progress payment will be between 15%-20% of your total loan amount.
Construction costs for building the house frame include:
- constructing the trusses,
- windows, and
- some of the brickwork.
Stage 3: Lock-up
This stage of the building process focuses on being able to close up the property.
This stage is generally one of the longest and requires the most money. It can take around four weeks and be between 20%-35% of your building loan.
This stage includes:
- construction of external walls,
- doors and windows, and
- insulation of the house.
Stage 4: Fixing
Fixing refers to all of the fixtures and fitting that are needed.
- kitchen cabinets,
- bathroom cabinets,
- shelves and cupboards,
- interleading doors,
- tiles and carpeting,
- constructing internal claddings,
- finalising plumbing, and
- finalising electrical systems.
This second to final payment can be between 20%-30% and can take up to six weeks to complete.
Stage 5: Completion
Your final progress payment is to cover the finishing touches.
This can include:
- fitting electrical appliances,
- installing fences,
- installation of ceilings,
- polishing walls and floors, and
- cleaning the site.
How Do You Apply For a Construction Home Loan?
Before you can apply for a construction loan from a bank or lender, you need to consider each step of the progress payments, how you want to perform them, and at what cost.
These things need to be presented to your lender as part of your application process.
- Research: have a clear idea of what you want to do, how, and how much money you can afford to borrow.
- Find a builder and architect: make sure that they are licensed and have good reviews.
- Draw up the plans: this will give you an idea of the cost of every piece of the puzzle, as well as the timeline.
- Determine the “out of contract” items: and how much they will cost via a separate formal quote.
- Get the plans approved: take note that this could take time, especially if there are amendments.
- Employ a mortgage broker: a mortgage broker can assess your plans and propose the lenders with the best construction loan product that best suits you.
- Apply for a construction loan: all the standard lending criteria apply in terms of documentation, as well as:○ council plans and permits,
○ a copy of your fixed-price building contract, and
○ any applicable insurances.
A construction loan makes planning easy by issuing progress payments throughout the various stages of construction.
It boasts the benefit of interest-only repayments with a progressive drawdown payment structure, only requiring a 5% deposit of your loan amount upfront.
Keeping track of everything can get overwhelming, and that’s where we come in. Our mortgage brokers from the Mortgage Agency form a personal relationship with you to learn your needs and goals and show you the steps you can take to achieve them easily.
We work closely with all parties involved, so you don’t have to while keeping you in the loop of all the developments. Our mortgage brokers have extensive experience with construction loans and are highly results-driven.
Our focus is to be effective and efficient, and we can’t wait for you to contact us and book your first consultation to begin your journey.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.