Building a house can be an exciting opportunity. For homeowners, it’s your chance to create a space unique to you by building a home from scratch or undertaking major structural renovations. For investors, you can enjoy depreciation benefits which come with building instead of buying. Either way, a construction loan can make it happen.
Unlike standard home loans, construction loans are specially designed to fund building or renovating a property. Let’s dive into how these loans work and what you need to know.
A closer look at construction loans
A construction loan is not your typical home loan. Instead of giving you all the funds upfront, the lender releases money in stages as your project progresses.
The reasoning behind these progress payments is to ensure funds are used for specific milestones like laying the foundation or completing the roof.
As construction moves forward, payments are made in stages:
- Foundation: When the base is laid.
- Framing: The skeleton of the house is up.
- Lock-up: The walls, doors, and windows are installed.
- Fixing stage: The interior work is complete.
- Completion: The builder hands over the keys and the final payment is made.
At each stage, the builder submits an invoice, and the lender ensures the work is on track before releasing the funds. This means you only pay interest on the funds you’ve drawn instead of the full loan amount, saving you money during the construction phase.
Before the final payment is made, a valuation must be completed to confirm the build has been carried out as per the original plans. Once the final payment is made, the loan transitions to principal and interest repayments.
It can be a stressful time building a house with many people still paying rent or a mortgage on their other house. To counter this, many construction loans offer interest-only repayments keeping your costs lower and providing you breathing room until your property is complete.
A fixed-price contract
In most cases, lenders require a fixed-price contract to limit risks like cost overruns. However, with rising construction costs, some builders find it challenging to commit to fixed prices. This can lead to delays or incomplete projects. Choosing a reliable builder and understanding your contract terms are essential to avoid surprises. At Loanscope we are experienced with building contracts and can guide you through this.
The risks and rewards of building
While construction loans offer flexibility, they come with unique challenges:
- Cost overruns. Even with a fixed-price contract, unexpected expenses can crop up such as building variations and costs excluded from the contract. It’s wise to set aside a contingency budget.
- Delays. Labour shortages, weather, or supply chain issues can slow progress, adding financial strain.
- Valuation changes. Property values can fluctuate during the build, impacting its value. Because valuations happen at different stages, you might face a situation where market conditions have shifted.
Be prepared and work with a mortgage broker who understands construction loans to navigate these risks.
On the flip side, there are benefits to building:
- Stamp duty savings. You only pay stamp duty on the block of land you buy saving you thousands of dollars.
- More say on your house. You get a say on how your home is built and looks, making it unique to you.
- First homeowner grant. If you’re building your first home, you could receive substantial savings when you build.
- Tex benefits for investors. When you build an investment property, you can claim depreciation and reduce your taxable income.
What if plans change mid-build?
Significant changes like adding a new room, require reapproval from your lender. This involves submitting updated plans and costs, so always communicate early and clearly.
Paperwork you’ll need to prepare
Applying for a construction loan requires more documentation than a standard home loan. Be ready to provide:
- Building plans
- Council permits
- Fixed-price contracts
- Builder insurance policies
- Builder licensure
Having these documents in order can speed up approvals and reduce headaches.
Navigating a complex construction loan
We’ve worked with a range of clients guiding them through the construction loan process and all its unique intricacies. In other words, we’ve seen it all.
One of our clients recently purchased a block of land in a new development area and signed a fixed-price building contract with a recognised builder. They planned to convert their existing home into an investment property and build a new home to live in.
Two separate contracts were required – one for the land and the other from the builder. However, a challenge arose when the builder was not ready with the contract when the land settled. We knew the client could incur penalties if they didn’t settle on time and advised them to go ahead with the land application. This ensured the land settled on time without incurring penalties from the developer.
Once the building contract was ready a week later, we organised the construction loan and guided the clients through the entire process, including progress payments and key milestones. In less than a year, the final payment was made, and the loan transitioned seamlessly to principal and interest repayments. Thanks to proactive planning and continuous support, the clients avoided delays, penalties, and unnecessary stress.
Ready to build?
Construction loans are a great way to bring your dream home to life, but they can be complex. Partnering with an expert mortgage broker ensures you have the guidance you need to manage progress payments, valuations, and lender requirements.
Here at Loanscope we’ve helped 100s of buyers build their dream home or investment property and would welcome the opportunity to work with you on your next project.
If you’re ready to get started or want to learn more, get in touch with our team today. We’ll help you navigate every step of the journey.
