If you are thinking of building a house, then you will also have to start considering your options for financing this home. A construction loan can provide you with the funds you need to enter into a building contract and realise your dream house. Here is our guide to construction loans with expert input from James Symond, CEO of Aussie Home Loans.
What is a construction loan?
A construction loan is a mortgage agreement specifically tailored to people who are building a house. “It’s a good idea to speak to an expert mortgage broker before you start looking for vacant land as they can help you find a loan that is suitable for your land and construction needs, this is where Aussie can assist,” Symond says.
The amount you are allowed to borrow is partly determined by the estimated value of the property upon completion. This is assessed based on your fixed price building contract from a licensed builder, council plans, and other related documents. Once the loan is approved and the construction is underway, the borrower is required to make progress payments (also known as ‘drawn downs’) to the builder.
How do progress payments work?
During the construction period, your builder will provide you with progress payment invoices. You will then fill a loan progress payment form (provided to you by the lender) to lodge it with them. “Your lender may also arrange for a valuer to make progress inspections at each drawdown, and this gives you the reassurance that an expert is double checking the quality of your builder’s workmanship”, Symond advised.
Payments that come out of your mortgage fund are made to the builder at each of the five stages of building a house, with interest and repayments of the loan calculated based on the funds used.
For example, if by the second progressive payment only $150,000 has been drawn down on a $400,000 loan, interest would only be charged on your account balance of $150,000 as well as fees. The benefit of this is that your interest repayments gradually increase over the construction period, giving you extra time to save.
“Drawing on the loan progressively is also easier on your budget than a traditional mortgage. Importantly, you will only pay interest on the funds used, and repayments are typically interest-only at least until the building is complete. When you’re ready to move in, the loan normally reverts to a traditional variable or fixed rate mortgage” says Symond.
What are the stages of building a house?
The five building stages are (1) Foundation, (2) Frame and brickwork, (3) Lock up – windows, doors, insulation, (4) Second fix – cupboard, electrical, etc. and (5) Completion. The expected completion date for each stage should be clearly listed in your building contract to give you an idea of a payment schedule. The percentage due to be paid in each stage varies by the builder. In most cases, however, each stage is worth 15-20% of the budget; or a particular stage may cost more, and require a larger portion of the budget.
What are the common mistakes people make when choosing a construction loan?
- choosing a regular mortgage and expecting that to work when building
- not ensuring the construction loan aligns correctly with the builder’s payment schedule and contract
- getting approval for a certain amount, then getting a bit carried away with the property’s design so you blow out your original approval amount and can’t get additional finance
What should I do to protect myself from a financial disaster?
Before you sign your building contract, double check that there is a finance clause to:
- protect yourself against unreasonable finance
- allow you to negate your contractual obligation if finance is not approved
- remove land from the market while you wait for financial approval
- give you time to obtain finance
When you apply for the construction loan, make sure to provide the lender with the complete final contract. If you must make any small changes along the way, try to pay the builder with your funds, or have the builder reimburse you for any discounts after construction is complete. If you go through the lender, they may need to reassess your loan all over again, which can complicate the process. As for larger changes, you should inform the lender as soon as possible and allow up to one month for the lender to reassess your loan.
It is worth shopping around for the best loan as this is a huge decision. Talk to multiple lenders, and even if you’ve had approval from one, take that offer to another lender to see whether they can find you a more competitive deal. This is often where mortgage brokers can add tremendous value as they do this hard work for you, saving you time, money and effort.
“Use the experts. Whether that’s a mortgage broker to help you secure the right finance to choosing the right builder; DIY when it comes to construction can cause more problems than dollars saved”, warned Symond.
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Zoe Langenberg
Zoe is passionate about coffee and interior design. You can find her most weekends exploring an art gallery or devouring a good book.
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