Finding a property that suits all your needs is not an easy feat. While building your dream home is a big project, it gives you flexibility and freedom to construct something perfect for you, from paint to pavers – and everything in between.
Home loans with a construction option are a bit different to standard home loans – they’re structured around progressive payments during your build to help manage the project's cash flow, rather than borrowing a lump sum.
Here’s a breakdown of how a construction option on your home loan works.
What is a construction loan option for your home loan?
A construction option, sometimes referred to as a building option, 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.
A construction option on your home loan gives you the funds to pay your licensed builder throughout the construction process or 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 does progressive drawdown work?
The main thing that sets a home loan with a construction option apart from a standard home loan is the progressive drawdown structure of the loan.
Before construction begins, the builder, often with assistance from a lender, will prepare a document outlining the total cost of the build and split the overall cost it 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 (or 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.
What is the difference between a home loan with a construction option and a standard home loan?
Aside from the progressive drawdown structure, there is one key difference between standard home loans and those with construction options for you to be aware of.
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 interest-only 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 up front – 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 do you get a home loan with a construction option?
Building your own property is a great opportunity to get everything you want in a home and a construction option may be the best way to make it happen.
The application process for this type of loan differs from that of a standard home loan. Borrowers will need to provide the lender with a number of relevant documents, 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.
Your lender will also need a bank valuation of your proposed new construction. This valuation may be conducted by a registered valuer nominated by, and on behalf of, your lender.
Once your loan is approved, you will then have to pay the deposit, a figure which may differ across lenders. 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). You can find out more about saving for a deposit and LMI here.
However, no matter how much planning you do, unexpected construction costs and delays are sometimes inevitable. So it helps to be aware of regulations, lending criteria and the building process. Check out the Australian Government’s yourhome website for more information.
Before making the decision to take out a home loan with a construction option, it’s a good idea to speak to an expert who may help you decide what’s best for you and your financial situation. Have questions? Call us on 131 900, learn more about construction home loan options, Westpac's other home loan products, or visit any branch across Australia to talk to your local Home Finance Manager.