What are construction loans?

What are construction loans?

Taking out a loan to cover the construction costs of your home can be very complex. There are a few important things you should sort out before applying for a loan.
Alexi Neocleous
Alexi Neocleous

With perennially high property prices across Australia’s capital cities, many savvy homeowners are looking for alternatives to buying. For some, building their dream home is more cost-effective than buying it.

Many lenders in Australia offer construction loans, which may be suitable for property owners who want to knock down and rebuild their existing homes.

Applications for construction loans are usually more complex than standard home loans. This is because there are many more parties involved in the financing arrangements, which increases the paperwork and costs.

Therefore it’s a good idea to talk to an expert with experience in securing home construction loans. A uno adviser can make this process easier for you, handling all the paperwork so you can focus on the construction itself.

How do I apply for a construction loan?

When you start the construction loan process with a lender, you’ll need to give them a copy of the contract with the builder you’ve hired. They will also ask for detailed plans of the construction.

On the basis of these documents, their experts will then estimate the value of your loan. How much you can borrow will depend on the projected price of the land, the construction, and the value of your home once completed.

After the lender approves your loan, they will send you a loan offer.

How will the lender pay my builder?

In general, lenders will pay the cost of construction works directly to the builder.

Before receiving payment, however, your builder must provide your lender:

  • approved final plans,
  • insurance details, and
  • the payment schedule.

Typically your builder will require ‘progress payments’ for defined stages of construction. To make these, you will have to submit a formal request to your lender by doing the following:

  1. Request an invoice from your builder.
  2. Contact your lender to get a drawdown request form.
  3. Fill out the form and send it to your lender together with the invoice.
  4. Wait for up to five days for your builder to receive the payment.

In some cases, lenders might want to come down and verify that your builder has completed the works described in the invoice. You will have to repeat these steps before each regular payment.

What about contractors?

It goes without saying that a builder alone is not enough to carry out all construction works. You’ll need to hire contractors to handle other parts of the project. This includes site clearing, setting up electricity, and landscaping – to name but a few specialist areas.

You will need to budget for these additional costs before construction begins. It’s a good idea to ask your builder to incorporate these quotes into the main contract, so contractors receive payment from the builder. However not all builders will agree to this.

What if there are changes to the contract?

Contracts sometimes change after the work has started. If this happens and your costs go up by even a modest amount, your lender may need to reassess your loan from square one.

The reassessment process usually lasts for up to one month. This might cause delays that could raise the overall cost significantly. To avoid this, you should make sure that the contract you give to the lender covers all the important details.

But if some changes do arise, they should be something you can pay for out of your own pocket.

How much can I borrow?

A construction loan is set up so that the borrower only pays interest on the amount drawn down from the approved loan amount.

Therefore if the loan amount is $500,000, but the borrower has drawn down $100,000, they will only pay interest on this amount.

A construction loan is usually interest-only for up to 12 months, before it converts to the principal and interest payments of a standard mortgage.

A good strategy is to make sure your loan is a little higher than the cost of construction. You would do this to create a small buffer that you can use for any unplanned expenses.

Also keep in mind that lenders can only release funds on the drawdown dates you’ve agreed on before the work began. So if you go overboard with spending, you’re at risk of running out of funds.

How much can I borrow?

Use uno's calculator to estimate your borrowing capacity.

Calculate NowCan I combine loans?

In some instances, you can go for two separate loans. Investors often choose this when they need money to buy the land and build a home. If you’re in the same situation, you might want to consider applying for a home loan in addition to a construction loan.

These two types of loans come with different terms and conditions. If you pair both these expenses up under one construction loan, you will have to repay it in full by the time the land settlement is complete.

Some buyers have expressed interest in combining a construction loan with a guarantor loan. Most lenders don’t have the know-how to properly handle this specific combination. Only a select few will be able to give you this option without causing errors and delays.

There are also situations where it’s difficult to calculate the cost of construction before it begins. If this applies to you, you can apply for a cost plus construction loan. They are much like construction loans but aren’t based on a fixed price defined in the contract.

Am I eligible for the First Home Owners Grant?

As the Australian real estate market has recently experienced somewhat of a boom, the government has changed its policy on grants and incentives for buyers and investors. To find out if you’re eligible for the First Home Owners Grant (FHOG), you should talk to an expert. You can also get in touch with your state government to confirm your status.

If you’re eligible, you should submit the application form to your lender at the same time you send them the loan application. When they receive your first drawdown request form, they will submit the application to the FHOG.

The FHOG payments will go directly to you to help you to cover any extra costs. If you talk to your mortgage broker, they may also be able to secure a payment shortly after the construction begins. This would allow you to make a payment towards the builder’s deposit if special circumstances arise.

What else should I pay attention to?

When you apply for a construction loan, you’ll need to submit a building certificate. It’s a document the local council issues as a formal approval of your construction plan.

If you’re buying an existing property, you should ask the seller to provide you with the building certificate. This is the only way of ensuring all renovations are legal and avoid having to pay fines as a new owner.

To get a construction loan, you must also have a formal contract with the builder. The document needs to comply with all the laws and regulations. If you agree to pay the builder in cash, no lender will be able to approve your loan application.

What to do next

Before you apply for a construction loan, it’s recommended that you talk to an expert. Here are some other things you can do:

  • Look up the latest interest rates.
  • Contact one of uno’s home loan advisers for help.
  • Use our calculator to see how much you need to borrow.

This information is general in nature, and you should always seek professional advice when making financial decisions.

Alexi Neocleous
Alexi Neocleous

* Two year fixed rate, owner occupier, P&I package loan with a maximum LVR of 70% and a loan amount >=$150k. Lender rates and products may change. We cannot suggest you remain in or switch to any loan until we complete our assessment. Fees and charges apply. ^WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. The comparison rate is calculated on the basis of a loan of $150,000 over a term of 25 years. ± All loan applications are subject to uno assessment and lender approval. uno does not guarantee that it will be able to find a customer a better loan than the one they currently have or to save them money.