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Construction loans and how they work

Home buyers in Australia are increasingly opting to build a new home from scratch.

According to the Australian Bureau of Statistics, 73,546 new dwellings were approved for construction between March 2017 and February 2018, an 8.9% increase from the same period a year prior.

The attraction of building a new home depends on the buyer. For a homeowner, it can be cheaper or more feasible to knock down their current home and build a new one. First home buyers are drawn to the option because it allows them to take advantage of First Home Owner Grants and concessions.

If you’re wishing to build a new home or upgrade the place you live in now, you will require a construction loan, which differs to a home loan for the purchase of an existing property.

A construction loan is structured around the building process, with borrower able to balance when payments needs to be made to the builder. These payments are made at key stages of the building process and are known as progress payments.

To apply for a construction loan, the lender will need a copy of the building contract/tender and the plans and they will also require an estimate of the potential market value of the completed property.

During the construction process, some lenders will require ongoing valuation and inspections before they pay the next instalment, to ensure everything is on track and within budget. This gives you peace of mind that builders or contractors are not being paid for incomplete or unsatisfactory work and it keeps them accountable.

Due to the loan being progressively drawn down, you’ll only be charged interest on the funds used so far. That means that if you have a $400,000 loan and you have only drawn down $100,000, you’ll only be charged interest on that $100,000 amount.

An advantage of a construction loan is that the construction period is interest-only, which minimises your repayments and saves you money. At the end of the construction process, your loan can be reverted to a principal and interest mortgage or you can keep it as interest-only.

While construction loans offer many advantages, there are some drawbacks to consider. 
Lenders will want to see all the paperwork, such as council-approved building plans and building contracts, before they approve a loan.

You may need a bigger deposit in order to be approved for a construction loan, as loan to value ratios are generally higher. In addition, you will have to factor in additional funds for finishing touches on your new home, as well as rent if you need to live elsewhere during the construction period.

Before going ahead with a construction project, make sure you speak to your local Mortgage Choice broker who can discuss your options and recommend the loan that suits your needs.

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