November 02, 2016
So you’ve found a vacant block of land, you’re ready to build your dream home, and you need to obtain finance – but which loan product best suits your situation? If you are building a new home, you most probably will apply for a Construction Loan.
In South Australia, under the First Home Owner Grant (FHOG) scheme the State government will provide a generous $15,000 grant to eligible First Home Buyers to help with their construction loan ( current as at 2nd November 2016).
What are Construction Loans?
A construction loan finances the construction of dwellings, where the loan funds are drawn down over time as the dwelling is built, rather than being provided by the lender in one lump sum.
These draw-downs are sometimes referred to as ‘progress payments’, and the lender usually sets a 12-month time limit on the draw down period.
It needs to be noted that not all lenders will lend for construction or they may charge you a higher interest rate, as not all are geared to accommodate the extra procedures necessary with construction loans.
Are these loans different to Standard Home Loans?
Although similar to obtaining a standard home loan, there are some specific guidelines that need to be followed in addition to those required for standard loans. You will need to provide the following:
- Copy of a signed fixed-price building contract between the borrowers and a licensed builder.
- Copy of the plans of the new property that have been approved by the Local Council. Note: the plans will generally not have to be approved at the time of application, but they must be approved before drawdown.
- Evidence that construction is being undertaken or supervised by a registered and insured builder who takes full responsibility for the construction and is able to provide appropriate guarantees as required by the various State legislatures.
- Details of insurance for builders risk.
- Copy of the detailed specifications and costings for the construction.
- Details (quotes) of any off-contract items that you will be adding to the home construction outside of the building contract.
Lenders will use the land purchase & construction details provided to them to calculate the Estimated On-Completion Valuation of the property, which will then determine the total loan that can be approved subject to their lending criteria for construction loans.
It is important to note that this estimated property value may not be equal to the total amount that you plan to spend on the property construction, since property valuations also take external market factors into account.
How do I pay the builder during the Construction period?
There are multiple stages of progress payments to the builder while the property is being built (5-6 usually); these are generally at Completion of footings/slab; Frame/Roof; Brickwork; Internal Fixtures; Lockup; and Final Handover.
At each stage, borrowers must provide the lender with a completed Loan Disbursement Authority and a builder's invoice. You may also find that the lender carries out an inspection of the work before making payment to the builder.
In all cases, you will be expected to utilise your own financial contribution towards the payment of the construction, before any progress payments are made from the loan funds.
For off-contract items (especially if multiple contractors are involved), most lenders will require the borrower to pay for these to the contractors themselves first, before reimbursing these costs to the borrower as one lump-sum only after all the builder’s payments have been completed.
What about Loan Repayments?
The required repayments during the construction period, while the loan is still being drawn down, generally only cover the interest cost. Interest is calculated on the amount actually drawn down, not the total amount approved (the end loan). Full loan repayments covering principal and interest begin once the loan is fully drawn down.
This special method of calculating the repayments helps the cashflow for rental borrowers who concurrently need to pay for rent at their current house, whilst also paying for the loan on the new property being built.
Can I purchase Land first, and then work on the Construction details later?
Sometimes you will find yourself in a position where you have been successful in locating a vacant block of land, but have not yet had the time to work with a builder to finalise the details of the home to be built. In this case, you can still proceed to apply for & complete the settlement for a Land Purchase Loan only – the primary document required is the fully signed contract for purchasing the vacant land.
If you are renting at the time of the land purchase, an important factor to take into consideration for a Land-Only loan is that you need to be able to evidence the ability to service the Land loan repayments in addition to the rental payments you need to make.
Also, some lenders may limit the land loan to a maximum lending ratio of 80% of the land value, and will stipulate a condition that construction of the new house must commence within 12 months of the date of settlement of the land loan.
For a Land loan, you do not need to provide any of the documents required for the Construction Loan as listed above. However, if you wish, you can separately apply for an “Approval In Principle” for the construction loan at the time of purchasing the land (using a best-case estimation of the construction cost).
For First Home Buyers
Under the First Home Owner Grant (FHOG) scheme, the Australian Commonwealth / State governments provide grants to eligible First Home Buyers who build a new home.
When applying for the First Home Owner Grant for a contract to build through a lender, it is important to remember that the approved FHOG payments will only be made on the first progress payment to the builder. These payments are not made available to applicants at the time of settlement of the land purchase.
For more information call our office on 8342 5688 or a/h on 0421 206543. To make an appointment fill out the online form on this page.