Construction Loans

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Construction Loans

Construction LoansConstruction loans are designed to lend money to people who are either building their own home or for people who are renovating their own home and a loan off the current value of the property would not fit into current lending limits.

Construction loans are most commonly used by first home buyers. They are very common in this segment of the market. Construction loans are typically bundled together with a land loan to finance the purchase of a property. Although other buyers eg. Second home buyers, investors are also eligible for the products.  Once the build is complete then they are combined to form one loan.

Construction loans vary quite considerably from standard “lump sum” home loans. We’ll go through the process below and explain how construction loans work and the steps you need to take to make this option benefit you.

Construction loans only cover the cost of the build or renovation of your property. It does not cover the purchase of land or any other mortgage you might have. They are designed only for the build portion of your project.

Typically people looking to build a property will first take out either a land loan to purchase the land, or the purchasers’ savings will cover the land purchase. In either case, the land loan will cover the purchase of the land and a construction loan will cover the build. Once both the land has been purchased and the build completed the financier will then wrap the entire loan into a more standard home loan product.

 

Getting One

For construction loans serviceability is an important feature. The bank needs to assess two things, one the current debt on the land loan (assuming there is one) and secondly the ability to service the construction loan as it drawn down. Finally, they need to assess the ability to service the loan once both the land loan (if applicable) and construction loans are then combined into a standard home loan product.

It’s a good idea to have a very clean credit history before applying. If you have outstanding debts, pay them off and get yourself into a good financial position. Banks will be looking for evidence of savings. This may well be the block of land you have purchased with your savings. The bank or other lender will see this as a good thing. Either owning or substantially owning the block of land you intend to build on is a great first step, this will act as your deposit on the property and count for you.

There are number of elements to a construction loan. The bank or lender will want to see the following items:

  • Council approved plans
  • Contract to build with builder (typically a fixed price contract)
  • Builders Insurance
  • Builder Licence to build

As a minimum unless you have those items a bank or other lender will simply not approve your loan and advance funds.

Construction loans are very different products to a standard home loan. Construction loans are typically interest only, meaning you only pay interest on the amounts being advanced – although this varies depending upon the lender. Interest only at this stage can be quite a useful tool for your personal cash flow, but be prepared for the loan to switch to principal and interest once building is completed.

 

How they work

Construction loans are loans of parts. No lender will advance all of the funds in one lump sum either to the builder or lender themselves. Typically a construction loan is advanced in stages. The number of stages varies depending upon the lender but typically five stages are used. These include:

  • Foundation
  • Frame and Brickwork
  • Lock Up
  • Second Fix (plastering etc)
  • Completion

Funds are advanced to your builder as each key stage is completed. Before funds are advanced to the builder a valuer will typically visit site to ensure that works are proceeding according to plan. They will make sure the progress payments are appropriate to the stage of build. This gives the buyer some confidence that the building is proceeding according to plan.

Typically, although this can vary by lender, banks will only advance funds once the stage of build has been completed and a valuer or surveyor has certified the works have been completed satisfactorily.

Progress payments are typically only made once all the cash you have to contribute is exhausted. This works in your favour as it means you’ll pay the least interest you have to.

Invariably there are alterations to a build contract. It could be as simple as a colour change to a wall, which has little to no price impact through to something more significant. Provided it is nothing too significant your fixed price contract will be able to handle the changes. Please note that lenders are highly reluctant to lend on contracts which are either cost plus or an hourly/day charge.

Construction loans are a very common way to getting your foot on the housing ladder. They are used in many cases, and for most home buyers are realistically the only way to buying a property.