A guide to construction loans

Building your dream home or taking on major renovations to a fixer-upper is no mean feat. But for many, a build or renovation project can be one of the best ways to get your dream home . Construction loans are a specific type of home loan designed to finance your build. Here’s how they work, and how they differ from regular home loans.

What is a construction loan?

A construction loan is a type of home loan that helps you fund the different stages of a large build project. With a traditional home loan, you borrow one lump sum to buy a property for a set price. With a construction loan, however, sections of your loan are paid out to your builder in line with the progression of your build. This helps ensure you’re not paying interest on funds you don’t need to use yet.

How does a construction loan work?

Construction loans use ‘progressive drawdowns’ or ‘progress payments’ to finance your build at different stages. Your licensed builder will document the total cost of your build and break it down into the different phases of construction. You’ll supply this breakdown when you’re applying for your finance.

Those phases are usually:

• Slab – laying the foundation, levelling the ground, plumbing, and waterproofing the foundation.
• Frame – building the frames, partial brickwork, roofing, trusses, and windows.
• Lockup – external walls, lockable windows, and doors.
• Fit out – gutters, plumbing, electricity, plasterboards, and the partial installation of cupboards.
• Completion – finishing touches, final plumbing, electricity, cleaning, and final payments for equipment and builders.

Your builder then sends an invoice for each completed stage, which is when your bank will release your funds. In some cases, phases and completion require an inspection completed by your bank. It usually depends on the project.

How construction loan interest is calculated

Construction loans work well for home builds because you only owe interest on funds that have been paid out as your build progresses. You won't owe interest on the funds you’re borrowing for your completion payment until they’re officially paid out to you.

What you need to apply for a construction loan

Construction loans are a little more complex than a standard home loan. Requirements differ from lender to lender, but usually you’ll be required to submit additional documentation on top of your usual personal financial information. Things like building permits, council permits and specifications, quotes from contractors, risk assessments, insurance policies, and other build-specific documentation.

Construction loans: things to consider

While construction loans can be the perfect solution for your big build, there are important things to consider.

• Going over budget is common with building projects. You’ll need to discuss any budget discrepancies with your bank.
• Timelines can blow out during building projects. This may affect your cash flow and personal finances during the build.
• Valuations are subject to changes in market conditions. This could make taking out a large construction loan more risky.

Taking on a construction loan is a big decision. A good lender will be able to talk you through the process and make sure you’re informed. Planning on building your dream home? Speak to one of our lending specialists to discuss your construction plans.