A construction loan, also known as a building loan, is a lending option that provides you funds to pay your Licenced Builder (or fund your Owner-Builder project) throughout each stage of your build or renovation process. It has a vastly different loan structure to home loans designed for people buying an existing home.
Building a home can be complicated. Seriously complicated if you do it yourself. Building requires a multi-disciplinary orchestration that pulls together builders, contractors, accountants, solicitors, architects, surveyors, councils, lenders, and others. You can always opt for a home and land package (which often offer a degree of certainty) but you won’t always, and certainly don’t have to, take this approach.
Essential Finance Hub has an extremely thorough understanding of various construction loans and can happily guide you through the process. We almost always identify the errors in contracts that often seem to be synonymous with the loan. The process can take a little longer than the typical loan for an existing property.
How do Progress Payments Work?
Once a construction loan has been approved and the property is being built, lenders will generally make progress payments throughout the various stages of construction. A builder will normally make a claim to the bank, the work may be assessed, and any payment is made directly to the builder at the completion of each defined stage.
- Slab or Base Down. This is an amount to help you lay the foundation of your property. It can cover the leveling of the ground, possibly concrete slab, as well as the plumbing and waterproofing of your foundation.
- Completion of Frame. This is an amount to help you build the frame of your property. It can cover partial brickwork, the roofing, trusses and windows.
- The Lockup. Lockup relates to the funding necessary to construct external walls, and fit windows and doors (thus the term ‘Lockup’, meaning your house is lockable and more secure).
- Fitout or fixing. The Fitout or fixing is an amount relates to the funds necessary to install the internal fittings and fixtures of your property. It can cover plastering or rendering, the part-installation of cupboards and benches, plumbing, electricity and gutters.
- Practical Completion. This is an amount for the conclusion of contracted items (such as final payments for builders and equipment), as well as any finishing touches such as plumbing, electricity, and overall cleaning.
How is the Loan Paid?
As construction loans are progressively drawn down, interest is normally calculated based only on the funds that were drawn. You only pay for the funds that were paid by the bank to the builder.
How Much is Paid at each Stage?
The amount paid at each progress payment stage is based on a percentage of the total costs of completion. Generally speaking, the banks generally schedule payout rates based on the following figures.
- The deposit: 5%
- The slab or base stage: 15%
- Frame stage: 20%
- Lockup stage: 20%
- Fit-out or fixing stage: 30%
- Practical completion stage: 10%
In the Northern Territory a slightly different schedule applies.
- The deposit: No more than 5%
- The slab or base stage: 10%
- Frame stage: 20%
- Enclosed stage: 25%
- Fixing stage: 30%
- Practical completion stage: 7%
- Final completion: 3%
In reality around 80% – 90% of the construction loan is drawn down at the lockup stage even though you’re a few months away from completion (longer if weather cases delays). However, banks will usually allow you to pay the interest on your loan until construction is complete, thus limiting your monthly obligations.
How long does construction take?
Construction varies from builder to builder, so ensure you research the market. For general scheduled home and land builds with a reputable builder you’ll be looking at the following schedule for completion:
- The slab or base stage: 2 weeks
- Frame stage: 3-4 weeks
- Lockup stage: 4 weeks
- Fit-out or fixing stage: 5-6 weeks
- Practical completion stage: 7-8 weeks
We’re happy to talk to you about builders we’ve dealt with that have demonstrated quality work.
Having Banks Pay the Builder Directly on Your Behalf
The banks will normally pay the builder on your behalf, and this removes the stress of your direct involvement. The process works as follows:
- Invoice. The builder will send you an invoice for completed work. This is called a “progress claim” and should only be made when a stage is verified as complete.
- Drawdown Request. You will be required to sign a drawdown request as provided to you by your lender.
- Send to Lender. Send the drawdown request form and the invoice to the construction department of your lender.
- Valuation. The lender may require a valuation to confirm the work is completed. This may require an on-site visit by a bank assessor.
- Payment. Funds will be advanced to your builder usually within five working days.
You should complete a manual walk-through your property to ensure each drawdown request is accurate. Have a suitably qualified individual accompany you if you require assistance. Do not approve the drawdown if work has not been completed to your satisfaction (you should consult the bank when these decisions are made).
Required Construction Documentation
It stands to reason that you’ll first need to be approved for a home loan. Construction loans are made available to most borrowers up to 95% LVR (which may include LMI).
Building Contract
A building contract is your building bible. It outlines the term, drawdown schedule, condition, final construction price, and inclusions of the build. You absolutely shouldn’t sign a building contact unless it has a provision on ‘Pending Finance Approval’. It’s also worth dealing with a builder that offers a refund on any deposit you might have paid; many home and land providers will require a deposit to hold your block of land, and based on their size and demand, will often provide this provision. In some cases where the clause doesn’t exist you may sign a ‘Draft Contract’. Either way, the bank will require the contract (and they’ll value your home as if it were fully built).
The contact should match the tender (if required by the bank). If the values differ – by even a small amount – a complete reevaluation may apply.
Banks will also require a copy of the building plans. They don’t have to be council-approved at this point but it’s an advantage; you don’t want any surprise costs imposed upon you by way of your designs.
The bank will require a copy of the Specifications. These specs include fixtures such as ducted or fitted air conditioning, what type of tiles or bench-tops are used, and other integrated fittings. This allows the bank to property evaluate your property as if it were a completed property.
Changes to the building contract, even by a small monetary value, may require the lender reevaluate your application as if it were an initial application. Ensure your final contract is rock-solid.
Quotes for Supplemental or Additional Works
Not all builds will include a driveway. Nor will builds always include basic landscaping or retaining walls. It’s important to have this information made available to banks. If using a house and land builder, try and source a company that provides a firm ‘Fixed Price Build’ – this is an all-inclusive cost that won’t cost you anything other than the standard agreed price.
Required Construction Documentation
A bank will require the following documentation prior to the first drawdown.
- Signed Building Contract. This is the finalised build contract.
- Quantity Surveyor Report. This requirement depends on the lender or the value of your property (usually more than $1 million).
- Council-Approved Plans. Depending on your state and council, council approval can take anywhere between 6-weeks and 14-weeks. Ensure you action this as a matter of priority as it can seriously delay your application and build.
- Builders Insurance: The building work – and its workers – must be safeguarded. You’ll need to provide evidence of Builder’s All Risk Insurance (covers risk to the building during construction), Domestic/Home Warranty insurance (if you’re using a registered builder – it covers risks such as non-completion by the builder due to death, insolvency or disappearance), and Public Liability Insurance (covers risks such as damage to property and injury to individuals). Once again, if using a home and land package builder they’ll have this readily available to you.
Construction Loan or Land Loan?
If you’re buying the land before considering construction, you may want to consider splitting the loan into a ‘land loan’ and ‘construction loan’. This means that funds will be advanced respectively only when required. Any LMI that may be applicable will be payable upon land settlement.
Grants and Guarantors
You may qualify for a Government grant which will assist with the purchase, and you should apply for any applicable grant at the time of your home loan application (we’ll walk you through this process).
A family pledge product is the only mechanism to borrow up to 100% of the loan amount, but it’s also a product that is difficult to organise with construction loans; you should contact us for details.
Essential Finance Hub are Experts
We enjoy dealing with construction loan clients, and we have a wealth of knowledge to help you navigate all the complexities – we’ll make it easy for you. Contact us for a general discussion and we’ll advise you of your borrowing position.
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