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Everything you need to know about construction loans

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Building a new home? It pays to get the right financing in place to ease the whole process.

Get all the info you need on construction loans.

If you’re thinking about building a new home, you may be surprised to learn that there are grants and loans specifically designed to help you achieve your goals. Along with the recent HomeBuilder grant, homeowners looking to get financing to help them build their new homes can also apply for a construction loan. 

Not sure what that means? No worries! Here’s everything you need to know about construction loans. 

What is a construction loan?

A construction loan is exactly as it sounds — a loan for those looking to build a property instead of buying an existing property. They are designed to help you cover your expenses while you’re building your new home. While all of this sounds simple enough, they can be a bit tricky if you don’t understand how they work. 

Construction loans have a different loan structure than standard home loans. They commonly use progressive drawdowns. This means that you will receive a series of payments at different stages of your building process rather than one lump sum. 

Throughout the construction phase, your loan will remain interested only, and you will only pay interest on the portion of the loan you have used. For example, if you are approved for a $250,000 construction loan, but you have only used $50,000, you will only pay interest on the $50,000 you have used.

After your home is completed, you can speak to your lender about continuing your interest-only terms. You can also change to a principal and interest loan. You may even choose to refinance. There are plenty of options available and it’s worth speaking to your lender before and after the completion of your home to work out a payment system that works best for you.  

What are progress drawdowns?

As mentioned, construction loans are paid out in stages, known as drawdowns or progress payments. Once your loan is approved and construction begins on your home, your lender will make payments directly to your builder after each of the following stages:

  • Slab down or base: This will cover the costs of building the base of your home. This includes levelling the ground, laying and waterproofing the foundation, and installing plumbing. 
  • Frame stage: The second drawdown will typically cover the framing of your home. This includes building the frame, partial brickwork, roofing, trusses and windows. 
  • Lock-up: This stage is called lock-up because it covers the installation of external walls, insulation, windows and doors — all of the items you need to be able to lock-up your home. 
  • Fixing or fit-out: This drawdown payment will cover the fit-out of your new home. That is all of the internal fittings and fixtures, including plasterboards, shelving, cabinets, doors, tiles and all internal cladding. 
  • Completion: As you might have guessed, this stage is to cover all the costs that come with putting the finishing touches on your property. This includes painting, polishing floors, installing fences and the overall clean-up of the site.

How to get a construction loan.

Since construction loans are a bit different from standard home loans, it only makes sense that the application process would be a little bit different as well. 

You will have to meet all of the criteria that you would normally have to meet to be approved for a loan, but you will also have to provide a few additional documents:

  • Building contract: This document must outline the construction stages, progress payment schedule, timeline, and all of the costs associated with each stage. 
  • Building plan: This will be the blueprint for your new home and should include the layout and size of the home you intend to build. It should also include information on all of the materials and finishes you intend to use. 
  • Quotations: If you plan to include any additional work that is not covered by your builder, you will need to include quotations for this work. This can include extras such as a pool, solar panels or landscaping. Your lender will assess the costs and whether or not they will add enough value to your home. 

In addition to all of the documentation, you will need to have a deposit. Typically, lenders will require 5% of the total building cost as a down payment.  

What are owner-builder mortgages? 

If you intend to build the home yourself rather than hiring a qualified builder, you may be eligible for an owner-builder loan. 

These types of loans are very similar to construction loans; however, they have much stricter eligibility criteria. This can include a much higher deposit (40% or more) and higher rates and fees. This is because your lender will see you as a higher risk. Unless you are a qualified builder, they can’t be confident that you will be able to complete the project to a professional standard.

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