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Do you need a Construction Home Loan?

It’s not easy finding a property that ticks all the boxes, and that’s why building a custom home is an appealing option for those who are wanting to add their personal touches. When you build your home, you’re able to reap the following benefits:

  • The opportunity to customise your home to suit your lifestyle. From floor-plan to colour scheme, the choice is all yours.
  • There’s less likelihood of regular repairs and maintenance for the first few years as everything will be newly built and installed.
  • You can choose to have a sustainable and energy-efficient home by incorporating modern technology such as solar panels. This may also help you save money on your utility bills in the long run.

If building a home is an appealing option for you, then there are a couple of funding options available for your new build, and one of them is a Construction Home Loan.

What is Construction Home Loan?

A Construction Home Loan is designed for people who are building a home or doing major renovations, as opposed to buying an established property.

Unlike a regular Home Loan, a Construction Home Loan has a progress drawdown structure where the full loan amount is released in stages throughout the building process to cover costs, rather than receiving it all at once at the start. Generally, you only pay interest on the amount that is drawn down, as opposed to the whole loan amount. You might find that several lenders offer Construction Home Loans that are interest-only during the construction period and then revert to a standard principal & interest loan.

How to qualify for a Construction Home Loan?

The process of getting your Construction Home Loan approved is different from applying for a standard Home Loan on an existing home. Lenders are cautious because it’s an investment for them and they need to ensure that the end product will be finished to a particular standard and is worth the money. Because of this, they employ strict qualifying criteria to protect their investment. In most cases, you will need to provide the lender with the following documents:

  • Council plans and permits
  • A copy of your fixed-price building contract
  • Detailed plans of your project, including blueprints and specifications
  • Information about the expected value of the property when completed
  • Any applicable insurance such as public liability insurance etc.
  • Details of your income and expenses

Before you apply for a Construction Home Loan, it’s important to note that you’ll need a qualified builder involved in the project, or else you will have trouble finding funding. Once you have applied for a Construction Home Loan, the lender will use the information above to assess your situation, which can influence and the amount you can borrow. When the build is underway, the lender will also require to conduct further valuations and inspections during the project.

How do Construction Home Loans work?

Once a Construction Home Loan has been approved, and the property build is underway, lenders will generally make progress payments throughout the various stages of construction. Progress payments will typically be paid directly to the builder at the completion of each stage below.

  1. Slab Down or Base: This stage requires approximately 15-20% of your loan (this may also include your initial deposit to your builder, which is typically 5% of your building contact price depending on your state/territory). This amount helps you lay the foundation of your property. It can cover the levelling of the ground, as well as the plumbing and waterproofing of your foundation.
  2. Frame Stage: This stage requires approximately 20% of your loan. This amount helps you build the frame of your property. It can cover partial brickwork, the roofing, trusses and windows.
  3. Lockup: This stage requires approximately 20% of your loan. This amount helps you put up the external walls and put in windows and doors (hence the term ‘lockup’, to make sure your house is lockable).
  4. Fitout or Fixing: This stage requires approximately 30% of your loan. This amount helps you install the internal fittings and fixtures of your property. It can cover plasterboards, the part-installation of cupboards and benches, plumbing, electricity and gutters.
  5. Completion: This stage requires approximately 10% of your loan to funds the conclusion of contracted items such as final payments for builders and equipment. It also finds any finishing touches such as plumbing, electricity, and overall cleaning.

As construction loans are progressively drawn down, interest is normally calculated based only on the funds used so far. For example, if by the third progress payment, only $150,000 has been drawn down on a $300,000 loan, interest would only be charged on $150,000.

Advantages and Disadvantages of a Construction Home Loan

Advantages:

  1. Financial protection: due to the loan’s payment structure, the builders and contractors are only paid for the work that has been done. Therefore, you can ensure that the work is completed to a satisfactory standard at each stage before providing payments for the next stage of work.
  2. High-quality workmanship: at each stage of the build, the quality of the works is assessed by the lender. If the lender identifies that the quality of work has been poor, then this allows you to make necessary adjustments to improve the build quality and save you from wasting all your loan a sub-par house.
  3. Reduce interest repayment: You’ll only pay interest on the amount that you’ve drawn-down instead of paying interest for the full loan amount. Should the worst happen, and the build gets abandoned, you don’t pay interest on construction that never happens.
  4. interest-only payment: Many Construction Home Loans are also interest-only at the start, which means your initial repayments will be lower. This can be beneficial, depending on your financial circumstances. However, keep in mind that the lower repayment is only temporary.
  5. Low stamp duty: Stamp duty is only paid on the land, not the home itself. This can make it cheaper than buying an existing house. For example, if you bought a block of land for $250,000 and spent another $300,000 building the house, you’d only pay stamp duty on the $250,000 for the initial land purchase. 

Disadvantages

  1. Stricter approval: Because the criteria for a Construction Home Loan is stricter than a regular home loan, getting approval for a Construction Home Loan requires a lot of paperwork. In addition, if you’re not building the home yourself, then you’ll need to have a long conversation with your builder to ensure that they can deliver the quality of work you need to get approved.
  2. Large deposit: The deposit required for a Construction Home Loan can be significantly higher than a standard mortgage if you are applying as an owner-builder.
  3. High-interest rate: The interest rate on some Construction Home Loans may be higher than regular mortgage loans. However, the rate will typically revert to a standard rate once the construction of the property is completed.
  4. Progress payments:┬áTypically, your lender will need to assess work carried out before they’ll release the funds for a progress payment. This process can be time-consuming and frustrating.
  5. Building risks: Building a new property from scratch can attract risks such as the following:
    • Going over budget for several reasons during construction.
    • Construction can be delayed due to weather.
    • The final product might not be worth what you thought it would be, or even what the lender thought it would be.

Taking the advantages and disadvantages of a Construction Home Loan into consideration, coupled with your research, you can now make an informed decision on how to fund your build. If you require assistance with your loan application process, the team at FutureNow Finance are here to help. We can help assess your current financial position and assist you in finding a loan that suits your need. Call 1300 013 730 or email hello@futurenowfinance.com.au.