Understanding the basics of construction loans

When to apply for a construction loan

Renovating that tired, beaten-up old bungalow? Or maybe you’re finally building that grand home you’ve been designing in your head for years, or taking the plunge into property investment? Whatever you’re working towards, we can help. We offer construction home loans (also known as building loans) using registered builders, with flexible conditions that recognise the cashflow challenges of a major project.

Construction loans offer flexibility

Building – or fixing up – your suburban castle can be a seriously stressful exercise. You need a firm project plan (that nevertheless allows for contingencies), backed by a well-organised team.

You’ll also need money, though you won’t want it all in a lump sum at the start. Specifically, you’ll need a home loan with special construction conditions.

A typical house construction scenario has five stages:

1. Laying the slab.
2. Roofing and tiling.
3. The internals.
4. Lock-up.
5. The final payment.

Paying each bill as it comes in means you won't pay interest on your building costs until the work has been done.

For example – say you've had a $250,000 loan approved and the first invoice in is for the slab – $50,000.

If you draw down the full loan, you'd be paying interest on $250,000. But a construction loan lets you draw down just the money you need – in this case, $50,000.

You can do this again at the other stages of the project.

Remember if you've chosen an interest-only period, you won't have to pay off the principal during this period. This gives you better cash flow which is handy if you're renting while building.

Keep in mind that as you draw down more of your loan, the amount of interest you pay will start increasing and you'll need to budget for that.

What is progressive drawdown?

Our construction loans let you draw down your loan in chunks or instalments. Most lenders offer this facility and may refer to these instalments as ‘progressive drawdowns’ or ‘progress payments’. We use both, but they mean the same thing – individual payments, drawn at various stages of the project, from a pre-agreed loan amount.

The obvious advantage of this loan is that you only pay interest on the money you use. To further lighten the load, our construction loans have interest-only repayment options during the build period.

Paying interest-only on your loan

Our construction loans are designed to ensure you don’t draw more than you need – or exceed the construction costs you’ve budgeted for.

That’s why our loans begin with an interest-only period. This means you’ll be paying interest-only – and only on the amount you’ve drawn down.

Your construction team

You’ll have your builder and architect, maybe even a project manager. You’ll also have plumbers, electricians and a horde of sub-contractors. You need a tight, cohesive team – and this requires planning, flexibility and (above all) great communication.

We see ourselves as part of the team, too. If you get a construction loan with us, we’ll assign a banker to you or your broker. They’ll work with you on things related to your loan, notably your progressive drawdowns and loan repayments.

If your situation changes at any time during the build, get in touch with us as soon as you can.

How do you get a construction loan?

Once you’ve chosen a registered builder, we’ll ask you for a suite of documents. This includes council plans and permits, your insurance provisions and a copy of your fixed-price contract including a Progressive Payment Schedule. Our brochure, Your Guide to Building and Renovating (PDF, 257KB), opens in new window, has the details of what you’ll need to provide.

Provided your documentation is in order – and subject to you meeting normal lending criteria – we’ll approve your loan. But keep in mind that each progressive drawdown has further conditions.

Our valuation requirements

Before you start, we’ll need an ‘as if complete’ valuation – an estimate of the market value of the land and proposed building/renovation. This ensures the amount of the loan is realistic – and that you have enough to get the job done. This protects you and us.

We’ll also check the quoted cost of construction. We’ll look at the plans, specifications and a signed fixed-price contract. These documents must meet industry standards (e.g. Master Builders Association or Housing Industry Association).

Insurance

The building work – and its workers – must be safeguarded. You’ll need to take out the following insurances before you can make any drawdowns.

• Builder’s All Risk Insurance: Covers risk to the building during construction.
• Domestic/Home Warranty insurance: You’ll need this if you’re using a registered builder. It covers risks such as non-completion by the builder due to death, insolvency or disappearance. Also covers structural defects due to builder negligence.
• Public Liability Insurance: Covers risks such as damage to property and injury to individuals.

Cost overruns

Cost overruns are when the building expenses exceed the planned progressive payments we agreed to at the start of your loan. We understand this sometimes happens. You might change your cladding from timber to brick. You might opt for wooden joinery instead of aluminium. Or you might simply decide you want double power points instead of single ones.

If you exceed the amount we agreed upon, talk to us ASAP about next steps. If we can’t provide additional funding, you’ll need to cover the extra cost yourself.

Your final payment

Once your work is done, we’ll need some last bits of paperwork before we release the final portion of money. Our brochure Your Guide to Building and Renovating (PDF, 257KB), opens in new window has the details.

Once the interest-only period of your loan ends, your loan becomes principal and interest. If you finish building before then, you can change the loan over to principal and interest. You’ll need to contact us to do that.