October 28, 2014
How is a construction loan different from other loans?
The vast majority of loans are taken for the purchase of a property or the refinance of an existing loan. In these cases the loan account is established and funds are made available as a lump sum. Construction loans differ because the account is established then the funds drawn progressively during building work. This blog describes the common scenario of building a single new home on land that was purchased previously.
Anyone planning to build a home should obtain an approximate building cost. One way to do this is through preliminary discussions with a builder. You should then make an allowance for other work not usually provided by the builder, such as demolition of an existing building, landscaping upon completion, and internal window furnishings.
Discuss pre-approval of your new finance with us. The construction loan may be added to an existing loan or setup as a new loan account. We will discuss the options with you. It is extremely difficult to increase your loan once construction is underway so you should also allow a contingency, perhaps for unexpected site costs or variations you may request when construction is underway.
The next steps are all about preparing the plans for your new home. You will spend time with a registered builder, perhaps an independent architect or draftsman, council, etc. Your builder will provide you with a fixed price building contract once your plans are finalised. Owner builders require other considerations not covered here.
When the building contract, plans and specifications are ready we will convert your finance pre-approval to formal approval. This starts with a valuation done on behalf of your lender, taking into account the existing land value plus the likely value of your proposed home.
Your total finance will be a combination of any existing loan plus the new finance calculated above. This will be compared with the expected final value of the property. It is a good objective to have your total finance less than 80% of the final property value.
The builder will start once your finance is approved. Typically they will issue invoices at the major milestones during construction, such as slab stage and frame stage, etc. You will need to contribute towards the first builder’s invoice(s) if you aren’t borrowing all of the construction cost. Your lender will start drawing funds from your approved loan to pay each builder’s invoice, but only after your agreed contribution has already been paid to the builder. When construction is underway your lender will control all funds in the new loan in accordance with the building contract until the home is able to be occupied. You will not be able to draw money from the loan to pay for variations to the building plans or unexpected costs.
Repayments on construction loans are Interest-Only during the construction period. The repayment amount only grows after each invoice is paid by the lender. This helps the budget of anyone continuing to pay rent or the mortgage on another property. Money needed for other costs prior to completion, such as demolition, will either need to be paid from your savings or we need to structure your finance a little differently.
Why you need to call us
This blog entry should be taken as general information only because there are numerous ‘exceptions to the rule’ among the hundreds of loans we have to offer, and these points don’t take your circumstances into account. You need to call us because your decision can be guided by our expert advice.