Understanding construction loans
Whether you’re building a new home from the ground up or looking to start major renovations, a home loan with a construction loan option can offer flexibility and help keep costs down. Here’s everything you need to know about how this handy home loan feature works.
What you'll learn
- How construction loans can help in build
- How construction loan options work
- How progress payments work
- How a construction loan option differs from a standard home loan
- How to apply for a construction home loan option
Finding a property that suits all your needs is not an easy feat. While renovating or building your dream home is a big project, it gives you flexibility and freedom to construct something perfect for you, from beams to brickwork – and everything in between.
Once you've made the exciting decision to leap into a rebuild, new build or major renos, a construction loan option on your home loan could suit you - let's outline how it all works.
Construction loans can offer convenience and help you save on interest repayments
Home loans with a construction loan option are a bit different to standard home loans – they offer the ability to make progress payments (progressive drawdowns) during your build to help manage the project's cash flow, rather than borrowing a lump sum.
This can make the construction process a lot more flexible and can save interest costs over time. It can also offer peace of mind, as money is only released with each stage of construction.
How construction loans work
A construction loan, sometimes referred to as an 'owner builder loan', is a type of home loan that is purposely structured for borrowers who are building or renovating their own home, as opposed to buying an existing property.
This home loan option gives you the funds to pay your licensed builder at each stage of your renovation in chunks or instalments. These are referred to as ‘progressive drawdowns’ or ‘progress payments’, meaning that rather than receiving your loan amount all at once in a lump sum, you may receive instalments of the loan amount as your build progresses through the various stages of construction.
How progress payments work
Before construction begins, the licensed builder, often with assistance from a lender, will prepare a document outlining the total cost of the build and split the overall cost into stages which will inform the payment schedule.
There are typically five stages of construction – here’s an example of a schedule:
- Slab – laying the foundation, levelling the ground, plumbing, and waterproofing the foundation.
- Frame – building the frames, partial brickwork, roofing, trusses, and windows.
- Lockup – external walls, lockable windows, and doors.
- Fit out – gutters, plumbing, electricity, plasterboards, and the partial installation of cupboards.
- Completion – finishing touches, final plumbing, electricity, overall cleaning, and final payments for equipment and builders.
Once each stage is completed, the builder will issue an invoice. Before releasing the funds (progress payments) directly to the builder, your lender may send someone to your property to verify that each stage of the build is progressing appropriately.
Your final progress payment may be subject to a satisfactory final inspection from your lender’s valuer, confirming the construction has been completed as per the original plans and specs.
Standard home loan vs home loan with a construction option
Aside from the progressive drawdown structure, there is one key difference between standard home loans and those with construction option.
While a standard home loan charges you interest on the full loan amount from settlement, a construction option divides your loan into stages of the building process. Typically, a construction option offers an interest-only rate and repayments during construction to help with cash flow. These will then revert to a standard principal and interest loan once your home has been fully built.
This means that you’ll only make interest repayments on funds that have been drawn down at that point in the process – not the whole loan amount upfront – which means lower repayments for you. However, it’s worth keeping in mind that the interest payments accrued during your construction period will gradually increase as your lender continues to release the money to pay your builder’s invoices.
How to get a construction loan
Lenders typically offer a 'construction option' on selected types of home loan; that’s what Westpac does too. Our Flexi First Option, Rocket Repay, Fixed Options Home Loans and our Bridging Loan all offer a construction loan option.
The application process for this type of loan differs from that of a standard home loan.
Most lenders will ask you to provide a number of relevant documents upfront, including council-approved plans and specifications, your signed and dated building contract, builders risk insurance policy details, quotes from contractors, as well as everything you need to apply for a regular home loan, like details of your income, employment, and credit score.
You will also need a valuation of your proposed new construction. Usually a registered valuer, nominated by or on behalf of your lender, will do this.
Can first home buyers get a construction loan?
We're often asked this and the short answer is yes, providing you meet our home loan eligibility criteria.
Deposit for a construction loan
Once your loan is approved, you will then have to pay the deposit, which may differ from lender to lender. Do your due diligence and consider things like interest rates, comparison rates, loan terms and how things will change if costs escalate.
At Westpac, we generally require a 20% deposit (and a loan-to-value ratio (LVR) below 80%) for home loans with construction options – similar to other standard home loans.
You can still apply for a construction home loan option with an LVR above 80%, but you will most likely need to pay lenders mortgage insurance (LMI). Find out more about saving for a deposit and how LMI could play a role.
Before things kick-off, it helps to be aware of regulations, lending criteria and the building process. Check out the Australian Government’s yourhome website for more information.
Not just a lender
The people who carry out your build and renovation will include licensed builders, subcontractors, insurance reps and more.
Our home loan specialists are experts in the construction process and will act as an intermediary between you and your suppliers. We’ll make sure your construction loan option progress payments align with the completion of construction milestones and that your repayment timings work with your financial situation.
If during the process, building plans, timings or costs change during construction (often the most stressful part of major renovations or builds), it’s a good idea to let your construction loan specialist know as soon as you can.
Will price variations impact my finance and repayments?
Cost increases usually require credit approval. If you’re with Westpac, we may need to get a revised valuation of the property, which can result in extra fees or a loan limit reduction. Make sure to speak to your home loan expert before committing to any cost changes.
If you're at the beginning of your journey, it's likely you will be considering things such as:
- Estimates for design costs
- Breakdown of costs for each stage of construction
- Availability of licensed builders and key contractors
- Council approvals
- The construction period / loan term (factoring in delays)
- Your financial position.
Then, it’s a good idea to speak to a lender who can help you decide what’s best for you and your financial situation.
To sum up
- Construction loans are for people who are building a new home or making major renovations
- They allow you to draw down your home loan in chunks, money is released as your build progresses
- You pay interest only on the amount you’ve drawn
- Payments are made directly to your building contractor
- You’ll need a home loan deposit, usually 20%
- Cost increases on the job can affect the amount you can borrow
- Construction loan specialists can be very helpful, they understand the process
Things you should know
This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice. Credit provided by Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.