December 09, 2021 by Bridgid Ryan
Building a new home – or renovating your current home, is a sure way to achieve your dream home, and a construction loan can help you get there.
How does a construction loan work?
The right size, the right outlook, even the choices of tiles or carpets that’s right for you. That’s what building a new home or undertaking a major renovation can mean. It’s exciting stuff!
It’s also a project that’s ideally suited to using a construction loan. That’s because construction loans are designed specifically for the building process. Here’s what it’s all about.
With a traditional home loan, the lender will hand over the full value of the loan in one payment. It means paying interest on the entire balance from day one.
A construction loan works differently.
Instead of handing over a single lump sum, a construction loan is paid to you (or more likely, your builder) via a series of payments that coincide with key construction milestones.
The exact timing of these progress payments can vary from lender to lender. As a rule though, they are usually made at the following stages:
- Slab stage: This is the amount you need for the builder to prepare the foundations and lay the slab for your property. This progress payment might be a big chunk of the total loan amount depending on whether you need the ground levelled or waterproofed.
- Frame stage: This is where your home really starts to take shape, and it can include the overall framework of your new home, and maybe some brickwork and windows.
- Lock-up stage: Once your new home is at lock-up stage all external walls, windows and doors have been complete – meaning you can literally lock the doors and walk away knowing it is safe from the elements.
- Fit-out stage: This progress payment covers the fit-out of your new house – installing the kitchen, completing the bathroom and finishing off plumbing and electricity. It’s an exciting stage as it’s almost time to move in!
- Completion stage: At this point your lender makes the final payment. The contracted services for your new home have been completed. All that’s needed is for you to settle in.
What are the advantages of a construction loan?
There are three main pluses of a construction loan.
- Potential interest savings
With a construction loan, you only pay interest on the amount of the loan handed over at each construction stage That’s very different from a traditional home loan, where – as we noted, the interest metre starts ticking on the full balance from day one.
This method of drip-feeding funds can mean big savings on interest with a construction loan. Once you home is complete, the loan usually reverts to a normal home loan.
- Interest-only payments until the build is complete
Construction loans often only require interest-only payments to be made while your home is being built. This can help you ease your way into living with a home loan especially if you’re a first home buyer.
- Your lender will check the workmanship
Under a construction loan, the lender will typically want to check the quality of work at each stage before handing over the next progress payment. This is a plus for you as it means an expert set of eyes is regularly checking the workmanship of your building project.
What to be aware of with a construction loan
There are a few things to keep in mind with a construction loan:
- A set timeframe
Lenders usually set a maximum timeframe for the complete drawdown of your loan. This has traditionally been six months. However, during the COVID-19 pandemic, some lenders have extended the maximum period for a construction loan to 12 months.
Nonetheless, it pays to finalise your building plans – and have everything lined up and ready to go before applying for a construction loan.
- Additional documents
When it comes to applying for a traditional home loan, your lender needs to have a look at your income and savings, household spending and your capacity to repay the loan.
The same applies with a construction loan, though you’ll also need to provide a few additional documents. These include a fixed price building contract, building plans approved by council and a copy of your builder’s licence.
The need to provide the extra paperwork is a great way to double check that you’re ready to go and have all your bases covered.
A construction loan can be the right tool for the job
As any good builder will tell you, a quality build is all about having the right tools for the job. It’s the same with a construction loan. It’s purpose-built for building a new home.
Download our free e-guide to find out more about constructions loans & building your own home from the Mortgage Choice team in Craigieburn & Sunbury here.
