A building (or construction) loan is one you might apply for if you were looking to build a new home, or to make some major structural changes to your existing home.
Generally building loans are written as a land and construction loan, where the borrower applies for a loan to cover cost of the purchase of land and the construction of the property at the same time.
Bundling the land and construction fees into one loan removes the risk for the lender that the finished dwelling could be valued less than the loan size (land and building costs). Depending on how your construction loan is set up, there will be varying conditions that need to be met throughout the construction of the home.
Building loans come with a lot more areas to consider than a normal home loan. Especially as there is the important aspect of actually building the house once your loan had settled! It’s recommended you have a lending specialist guide you on a building loan application to help you understand the full process – and will make sure your lender gets it right for you!
How does a building loan work?
Instead of your lender providing you with the full loan amount once the loan is settled, building loans are typically advanced in stages, called ‘progress draws’.
The number of stages can vary, but there are typically 5 stages used to determine payments.
|Construction loan stages|
|1||Foundation||(levelling and laying foundation)|
|2||Frame and brickwork||(roofing and insulation)|
|3||Lock up||(securing the structure with windows and doors)|
|4||Second fix||(plastering and sealing)|
|5||Completion||(painting, installing appliances and fittings)|
The money is advanced to your builder upon completion of each stage, in-line with the builder’s contract.
To ensure work is being completed according to plan, and that the payments being advanced align with the stage the construction is at, your lender may send a qualified valuer to visit the building site.
At each stage you should inspect the work completed yourself as the lender will ask you to sign an authority saying you are happy with the work completed and authorise payment to your builder. If there is anything in dispute with the builder it may be best to sort this out prior to asking the bank to make payment.
Your lending specialist can guide you also – especially if you are interstate or can’t inspect the property yourself. The lending specialist can’t do this for you but they can help manage the progress draws with your lender.
Related Post: Find out about low deposit building loan options
How do the repayments work during the construction period?
As you’ll be given funds in instalments, most lenders will typically only require you to pay interest on the amount you have drawn.
For instance, if you are given a $500,000 construction loan but have only drawn $100,000 of it, you will only pay interest on that $100k. This means you actually save money in interest payments throughout the construction.
Once construction is complete, and all progress draws have been made, you’ll then begin making full principal and interest payments on the loan. You can also choose to have your construction loan converted into an ordinary home loan at this stage, or combine it with other loans.
What happens if construction doesn’t go to plan?
When building, it’s not uncommon to see alterations made to the building contract.
If your change is minor and should not have a major price impact you can try to pay for it yourself to avoid any changes to your loan contract.
However, if you want to make structural changes such as adding an additional room or making changes to window placement, you’ll need to speak to your lender or lending specialist. If a reassessment of your loan is required your build may encounter delays.
Once again, this is why engaging a lending specialist upfront can help you understand all aspects of a building loan, and help you understand the impact of any potential changes throughout the process.
How can I get a building loan?
Lenders are typically more cautious when it comes to construction loans. It’s a very different product to standard home loans and lenders want to assess their risk more carefully. That’s why applying for and getting approved for a construction loan is a more complex process.
For starters, there is a lot more paperwork for you to organise such as building contracts, plans and specifications. Your lending specialist will help guide you, collate and check all your documents, and ensure it is presented to the lender credit approval team in the right way.
Your lending specialist will:
- Help you choose the right home loan and fully explain the process. This may also involve getting you a home loan pre-approval before you have finalised your building contract. At this stage you will also get a firm quote on any applicable fees or whether mortgage insurance (LMI) will apply to you
- Review your credit history and ensure you can afford the loan you need to build your home. This will involve reviewing your income and expenses. If it’s for an investment they will also help you ascertain how much rent you may receive. Your LJ Hooker Home Loans lending specialist can introduce you to a property manager for a firm quote and this can also give you an opportunity to ensure you have a tenant ready to move in as soon as your home is complete
- Assess your deposit and clearly communicate with the lender credit team how your deposit is structured. This may come from a combination of sources including savings, sale of assets, a government grant incentive, or a gift from a family member. It’s important the lender fully understands how your full deposit will work
- Help you collate everything else you need to get a full approval on your building loan, and arrange a valuation for you on the property. With a building loan this will involve obtaining:
- Council approved plans
- Contract to build with builder (typically a fixed price contract)
- The building plans and specifications
- Builders insurance
- The land purchase contract (if happening at the same time)
- First Home Owner’s Grant application (if applicable)
Related Post: Why a home loan pre-approval may be important to you
What happens when construction is complete?
Your lender will usually arrange a final property inspection to take place to confirm that the property is finished to the proposed specification.
Construction loans are generally written as principal and interest (P&I) loans, however during the construction period repayments are interest only (IO). Construction periods generally range from 6-12 months. Once construction is complete, you will start making regular loan repayments – just like a regular home loan. At this time your lending specialist will speak to you on whether you want a variable or fixed rate home loan, and how the off-set will start working if you selected that product option.
Getting a building loan may seem complicated – but it’s not!
An LJ Hooker Home Loans lending specialist will help make everything simple for you. Working with you and your builder, we’ll take care of all the paperwork, and help you focus on the important design aspects of your new home.
We can even start with a planning session before you take the 1st step, so you’ll know whether building a home is a good option for you!
Check out our First Home Buyer difference
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This article is prepared based on general information. It does not take into account individual financial objectives or needs and is not financial product advice.