August 25, 2022
Shehan Wijayasinghe

A complete guide to construction loans

If you’re building a new home or renovating your current one, chances are you’ll need a construction loan to finance your build. Unlike a standard home loan, a construction loan is structured around the building process, allowing the borrower to make progress payments to the builder at key stages of the build.

A complete guide to construction loans

If you’re building a new home or renovating your current one, chances are you’ll need a construction loan to finance your build.

Unlike a standard home loan, a construction loan is structured around the building process, allowing the borrower to make progress payments to the builder at key stages of the build.

These progress payments, also known as ‘progressive draw-downs’, are released periodically from the loan when each payment is due, rather than all at once.

Whilst the main advantage of a construction loan is that you only pay interest on the money you use, most lenders will charge a premium for this feature.

If you’re wondering how you would go about getting a construction loan, we’ve outlined the four key steps in the process below.

Stage One: Preparation

Stage one involves preparing the necessary information and people to ensure the building process is carried out as smoothly as possible.

Firstly, you’ll need to source your builder and get an estimation of the total project costs. Once your plans are finalised, we (the mortgage broker) will source a pre-approval that meets the build’s financial requirements.

After your chosen builder drafts an unsigned build contract (including all specifications), we’ll order a valuation for the home. From here, the standard loan process will apply, including appropriate documentation and settlement. The lender will also provide you with your builder commencement letters.

Stage Two: Build Commencement

As your build gets underway, your builder will start invoicing you progress payments at different stages of the process. The builder will also need to send you a number of bank-specific items (insurance details etc) which we will forward to your lender.

Banks will typically group the construction progress into stages and make payments to your builder upon their completion.

Most commonly, these progress payments are grouped into the following five stages:

  1. Slab - The measuring and pouring of the foundation slab, with the building deposit often included in this payment as well.
  2. Frame - The exterior walls and frame of the building, including insulation, support structures and conduits for electrical and plumbing.
  3. Lock-Up - Referring to the ability to now “lock-up” the property with remaining windows, doors and walls now installed.
  4. Fit Out - Includes the installation of internal fittings and fixtures such as lighting, plumbing and electrical.
  5. Completion - The final progress payment is typically made upon the total completion of the build.

You will then receive confirmation after the bank finalises these progress payments to your builder.

Stage Three: Build Completion

The final progress payment will be prepared once the build has been completed and a Certificate of Occupancy has been achieved.

The bank will then organise a final inspection and valuation to assess whether the build was completed successfully and as expected.

After managing any defect fixes and organising a handover date, the final payment will be made and you can move into your new home.

Stage Four: Post Build

At the completion of the construction loan, the normal home loan process will start and your mortgage repayments will kick in.

Since the building timeframe could take anywhere between 6-24 months to complete, your interest rates will likely have changed during that time. This is when we’ll look to refinance your mortgage to a lower rate as the construction loan feature will no longer be required on your home loan.

Our best tips for construction loans?

  • Where possible, we recommend negotiating a fixed price contract. Although this is generally difficult when contracts exceed $1 million, a fixed price loan is often the safest way to protect yourself from rising interest rates and costs.
  • Do the appropriate due diligence when choosing your builder. Research how long they’ve been in business and their track record with previous builds, as well as the pride they take in their work. Choosing an unreliable builder can lead to enormous headaches and leave your build at risk of going over budget.
  • Do not sign the build contract until you have sourced pre-approval for the construction. This makes sure you don’t risk losing any of your deposit and entering into a contract without finance.
  • Ensure you have a contingency for potential building variations.
  • Understand the upfront contribution you will have to make, including how much and when it is needed.
  • Although interest-only repayment options are usually available for construction loans, we always recommend you begin paying down the principal as soon as possible.

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