What is a construction loan?
A construction loan, also known as a building loan, is a type of loan that’s specifically designed for borrowers who are looking to build a new home or to make major structural changes to their existing home.
Construction loans are often written as a land and construction loan, where the borrower applies for a loan to cover the cost of the purchase of land and the construction of the property at the same time. Bundling the land and construction fees into one loan removes the risk for the lender that the finished dwelling could be valued less than the loan size (land and building costs).
When to apply for a construction loan
There are several different scenarios that call for a construction loan rather than a traditional home loan. This includes:
New builds: Planning on building a new home from the ground up? Construction loans allow for progress payments at different stages of the project, making them ideal for new builds.
Remodelling: If you’re planning on adding an extension or changing the layout of your home, a construction loan for a remodel is often a good way to go. Much like a new build, the funds are disbursed in stages for remodels.
Renovating: While renovations typically aren’t as extensive as new builds or remodelling projects, they can still cost a pretty penny. With this in mind, construction loans offer structured payments, enabling borrowers to pay only for completed work rather than a lump sum.
How does a construction loan work?
Unlike traditional home loans, construction loans are paid in stages, known as ‘progress draws.’
While the number of stages can vary, most construction loans are paid out in the following five stages:
Foundation - levelling and laying the foundation
Frame and brickwork - roofing and insulation
Lock up - securing the structure with windows and doors
Second fix - plastering and sealing
Completion - painting, installing appliances and fittings
At the end of each stage, your builder will issue an invoice for the work completed. In some instances, your lender might send a qualified valuer to visit the building site to confirm the work has been completed. From here, your lender will send an advance directly to your builder.
What is a low doc construction loan?
Short for low documentation loans, low doc construction loans are a specific type of loan that requires less documentation than regular construction loans.
These types of loans typically cater to people who are self-employed, small business owners or those with variable income who may find it challenging to provide traditional income verification, like tax returns or pay slips.
Although these loans can help people who would otherwise struggle to get into the housing market, they often come with stricter lending terms and higher repayments to cover the additional risk. Not to mention, not all lenders offer low doc loans, so it can be helpful to work with on of our mortgage broker’s to help you find a loan that suits your financial situation.
You might also be interested in: NSW releases housing pattern book aimed at boosting construction
How do the repayments work during the construction period?
Construction loans are paid in instalments, meaning most lenders will typically only require you to pay interest on the amount you have drawn.
For example, if you’re given a $500,000 construction loan but have only drawn $100,000 of it, you will only pay interest on that $100k. This means you actually save money in interest payments throughout the course of the construction project.
Once construction is complete and all progress draws have been made, you’ll then begin making full principal and interest payments on the loan. Alternatively, you might choose to convert your construction loan into an ordinary home loan or combine it with other loans.
What happens if construction doesn’t go to plan?
From new builds to simple renovations, construction projects are often notorious for going off track. If you’ve ever watched an episode of Grand Designs, you’ll understand this. With potential project delays in mind, it’s not uncommon to see alterations made to the original building contract as work progresses.
If the proposed changes to the plan are minor and aren’t likely to have a major impact on the price, you can try to cover the difference yourself to avoid any changes to your loan contract. However, if you want to make structural changes, like adding an additional room or making changes to window placement, you’ll need to speak to your lender. If your lender needs to reassess your loan, your build might be pushed out.
How to apply for a construction loan
Construction loans are typically more risky than ordinary home loans, so lenders will often complete more checks as part of the application process. While the basic application process is similar, there are a few key differences that set construction loan applications apart from traditional home loans.
Here’s how to apply for a construction loan.
Step 1: Choose the right lender
Firstly, you’ll need to choose a lender. Not all lenders offer construction loans, so it’s important to do your research to find a lender and a loan that suits your needs. If you’re not sure where to start, ask one of our Aussie brokers for advice. They can sort through hundreds of options to find a construction loan that fits your specific situation.
Step 2: Prepare and submit your project plans
Before applying for a construction loan, you’ll need to define your project in detail. This involves securing a licensed builder, creating a building plan, finalising a timeline and obtaining council approval. Ultimately, lenders want to make sure that the value of the completed property won’t be lower than the loan size.
As part of the application process, you’ll need to submit a range of documents specific to the project, including:
Signed contracts with your builder (typically a fixed price contract)
Building permits, council approvals and any necessary licences
Detailed cost estimates and construction timelines
Insurance certificates for construction and liability
Step 3: Provide supporting documents
As part of the application process, your lender will assess your suitability for a loan based on your income, debts and general financial situation. With this in mind, you’ll typically need to provide documents relating to:
Identification: This includes primary documents, like a passport or driver’s license, as well as secondary documents, including a Medicare card or utility bill.
Proof of income and assets: Tax returns, pay slips, bank statements and property titles for any investment properties.
Debts and liabilities: You’ll need to disclose any other loans or debts, like credit cards, car loans and personal loans.
Living expenses: You’ll often need to provide a detailed breakdown of your monthly expenses, including groceries, rent, bills, transport, recreation and other miscellaneous expenses.
Step 4: Complete a property appraisal
While most lenders will complete an appraisal as part of the loan application process, when it comes to construction loans, the aim is to estimate the property’s value once construction is complete. This helps to determine the final loan amount and ensure it aligns with the property’s expected value after the build.
Step 5: Await loan approval
If your loan application meets the bank's lending criteria, they’ll provide formal approval. After signing the loan agreement, the loan amount is divided into progress payments that align with the construction stages.
Whether you’re looking to renovate your kitchen, add an extension or build a home from the ground up, your local Aussie Broker can help you find a construction loan that suits your needs. Book in for a free^ chat today.