What you should know about construction loans?

Building a home is challenging, but if you’ve decided to go down this path, a construction loan from a reputable lender can reduce your stress. Although such loans may seem similar to regular home loans, there are several key differences you need to know before breaking ground.

What are construction loans, and how do they work?

A construction loan is designed for those planning to build their own home instead of buying an existing property. Such a loan is structured differently from standard mortgages, and the primary purpose of these loans is to fund your building project as it progresses. 

Such loans generally have a progressive drawdown feature. It means you can borrow or "drawdown" from the loan as required to pay the construction expenses. You’ll have to submit an official estimate of the construction cost to the lender to determine the maximum loan amount, and you’ll need an initial deposit of five per cent of the total estimated cost before your loan is approved. During the construction period, generally set at 12 months, you’ll pay only the interest to keep your repayments to the minimum. The lender releases a portion of the loan amount during each stage of the construction process.

Generally, construction is broken down into the following stages:

1. Site levelling, plumbing installation, and foundations - up to 10 per cent of the total cost
2. Constructing the frame and roofing of the house - between 10 and 15 per cent of the total cost
3. Building external walls, doors, insulation, and lock-up - up to 35 per cent of the total cost
4. Fit-outs including electrical and lighting, kitchen, shelving, and bathroom - between 15 and 25 per cent of the total cost
5. Completion and finishing - between 10 and 15 per cent of the total cost

If you take out a construction-to-permanent loan, the interest becomes payable only after the house is completed. You then make principal and interest repayments just like you would if paying off a regular mortgage. 

When you apply for a construction loan, the lender will approve your application only if a licensed contractor is responsible for the project. There are some lenders who may allow you to take out a loan even when you’re not using a licensed contractor. In such a case, you either need to be a licensed contractor yourself, or you need to qualify as someone who is in the same trade.

How do you apply for a construction loan?

To apply for a construction loan, you’ll need a building contract, plans and quotations from the contractors, along with your proof of employment and income documents.

Before starting construction, you and the builder must provide a copy of the fixed-price building contract and a copy of the plans approved by the local council to your lender. Apart from these documents, it’s also necessary to present the Construction Certificate, Certificate of Currency, and documents related to Public Risk Insurance. You need to hand over these documents to the lender before the first drawdown request. It’s a good idea to give the documents to the lender at least two weeks before you plan to start the construction process in order to prevent any delays.

What happens if the building contract changes?

If you make changes in the building contract, the lender may think about reassessing the loan, which can delay project completion. So, to avoid such circumstances, you should always finalise the building contract before giving a copy to the lender. If you do make any significant changes, then you need to tell the lender immediately. It may take up to a month for your lender to reassess the loan.

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