Construction finance - how does it all work?

September 03, 2014
Jo Patterson

Construction finance - it is without doubt the least understood area of mortgage financing and where accurate information and expert advice are absolute essentials to making good decisions.

Nobody likes to purchase a block of land and pay a non-refundable deposit to the builder, only to find you can’t get the finance to build! 

I bought a block of land in Mandurah and built my first home in 2003.  I had just turned 22 and was lucky enough to have been working in banking at the time, so I had a reasonable idea of the process when it came to getting finance.  However, I had never built a house before, so the terms “drafting plans”, “variations” & “pre start” had me a little flustered. 

This leads me to creating my “construction series” blog, helping those building for the first time, to understand a bit more about building that dream home…. 

So, how does it all work? 


A bank lends against the value of your property, therefore they will arrange for a valuation company to complete one of the following types of valuations:

• Current Market Value (such as a vacant block of land)
• On Completion Market Value (sometimes called a TOC valuation – Temporary On Completion)

There is another very important value to consider – it’s called Contract Value. They are not the same...

Let’s say your house is worth $400k and you wish to spend $50k on renovations. Will its total value be $450k?

The answer is it depends on what you spent the money on and whether you got “value for money”. So for example, if that $50k was for a new family room and included what you spent on a new TV and furniture, then the answer is obviously not.

The same principle is true with construction valuation –that is based on what your house will be worth in the context of similar houses in the surrounding suburb.

Let’s say you have a contract to pay a builder $250k, plus $50k in "extras" to build a house on land you recently purchased for $250k. 

Is that house worth $550k? Is that $50k in "extras" actually all “added value”? (Some land sales include a rebate for building within a certain timeframe.  Builders may include home theatre packages or landscaping that not all banks/valuers will include as ‘extra value”).


Here is a FACT – the valuer will give an opinion and the bank will lend against that opinion. You will pay the builder what you agreed.

So if the bank valuer's opinion is $550k – all parties are smiling – bank, builder and you.

But what if the bank valuer's opinion is $525k? This is called a valuation shortfall. This is THE SINGLE MOST IMPORTANT FACT in construction and leads to the most tears and heartache in EVERY form of construction.


If you don’t have those cash reserves – harsh but true – the project will NOT commence. Your deposits to the builder are potentially forfeited and you are stuck with a lovely set of plans, but no house. (This is unless it is “off the plan” where this same issue arises, only later in the process – I will be covering that issue in an upcoming blog).

Lesson – Don’t commence a building project unless you have a reasonable cash reserve.

A 'reasonable' cash reserve is individual to each situation & with the aid of an expert it is possible to estimate what it is you will need to get your house off the plans and into reality! This is done with what is called a “Build Pack” – a set of documents that is given to your finance broker so that we can obtain a TOC valuation. 

In order to obtain your Unconditional Finance Approval I will need; 

  • Land contract (for new) or Council rates notice (for existing)
  • Fixed Price Build Contract (plus Variations*)
  • Building Schedule (your selections and finishes)
  • Building Specifications (shows it meets building standards)
  • Contract Plans (signed and dated)
  • Engineers Report (sometimes this is supplied , sometimes not)

In order to get the bank to release funds by way of Progress Payments to the builder I will also need; 

  • Council approval
  • Builders Insurance specific to your site 

Variations- you can make variations to the contract– BUT – if you want the bank to lend for them I must have these with the build pack.
Any variations that come later (and there are almost always variations at “pre start”) MUST be paid for from your own cash reserves.

Watching your home grow from paper plans to a physical property, and then moving in to "live your dreams" is the very reason why I enjoy construction finance. 

As your trusted mortgage broker in Rockingham, I can give you expert advice on how to get started on the path to building your own home. Contact me today on 9535 3888 to arrange a free consultation.

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