Construction Loans: What to Know Before You Build
Building a custom home is an exciting journey that lets you create the exact living space you've always wanted. Whether you're looking at house & land packages, planning a custom design, or working with a registered builder on a project home loan, understanding construction finance is crucial to turning your vision into reality.
Unlike standard home loans where you borrow a lump sum upfront, construction funding works differently. Let's explore what you need to know about building new home finance and how construction loans can help you build your dream home.
How Construction Loans Work
A construction loan is specifically designed for building a new home rather than purchasing an existing property. The key difference? Lenders only charge interest on the amount drawn down, not the full loan amount from day one.
Here's how it typically unfolds:
- The loan amount is released in stages through a progressive drawdown system
- Funds are paid out according to a progress payment schedule
- Each release happens after a progress inspection confirms work completion
- You'll pay interest only on what's been drawn, not the total approved amount
This structure protects both you and the lender, ensuring money flows as your home takes shape.
Understanding Progress Payments and Draw Schedules
Your construction draw schedule outlines when funds will be released throughout the building process. Typically, this happens in five or six instalments that align with major construction milestones:
- Base stage (once the slab is laid)
- Frame stage (when the frame is up)
- Lock-up stage (roof, windows, and doors installed)
- Fixing stage (plumbers, electricians, and internal fittings)
- Completion stage (final touches and handover)
Each stage requires a progress inspection before funds are released. This Progressive Payment Schedule ensures quality construction and that your money is being spent appropriately. Be aware that lenders charge a Progressive Drawing Fee for each inspection, which typically ranges from $200 to $400 per drawdown.
Types of Building Contracts
When arranging construction finance, the type of building contract matters. Most lenders prefer fixed price building contracts, which specify the total cost upfront. This provides certainty for both you and the lender.
Alternatively, a cost plus contract adds the builder's fee on top of actual costs. While this offers flexibility, some lenders are more cautious with these arrangements, particularly for owner builder finance.
Your registered builder will prepare the progress payment schedule based on your contract, which your lender will review during the construction loan application process.
Construction to Permanent Loans
Many borrowers choose a construction to permanent loan, which seamlessly transitions from construction funding to a standard home loan once building is complete. This saves you from reapplying and paying additional establishment fees.
During construction, you'll typically have interest-only repayment options, paying only the interest on funds drawn down. Once construction finishes, the loan converts to principal and interest repayments based on the full loan amount.
What You'll Need to Get Approved
Lenders require several documents for your construction loan application:
- Council approval and development application documentation
- Council plans approved by your local authority
- Fixed price contracts with a registered builder
- Proof you can commence building within a set period from the Disclosure Date (usually 6-12 months)
- Evidence of suitable land ownership or a land and construction package
If you're looking at a land and build loan, you might purchase the land first, then apply for construction finance separately, or combine both into one land and construction package.
Beyond New Builds: Other Construction Finance Options
Construction loans aren't just for building from scratch. They can also fund:
- House renovation loan projects for major home improvements
- Home improvement loan requirements for extensions
- Off the plan finance for apartments still under construction
- Spec home finance for builders constructing homes to sell
- Custom home finance for unique architectural designs
At Mortgage Path, we can access Construction Loan options from banks and lenders across Australia, finding solutions that match your specific building project.
Interest Rates and Costs
The construction loan interest rate is typically similar to standard variable home loan rates. However, you'll need to budget for additional costs:
- Progressive Drawing Fees for each inspection
- Potential higher interest rates during the construction phase
- Building insurance and other construction-related insurances
- Any cost overruns if your project exceeds the original budget
Making additional payments during construction can help reduce your interest burden and give you a head start on paying down the loan amount.
Working with Mortgage Path
As a renovation Finance & Mortgage Broker with extensive experience in new home construction finance, we understand the complexities of construction funding. We'll help you understand your progress payment finance options, compare construction loan interest rates, and find suitable land if needed.
Whether you're a first home buyer building your first property, looking to refinance into a construction loan, or exploring your borrowing capacity for a custom design project, our team can guide you through every stage.
Building your new home should be an exciting experience, not an overwhelming one. With the right construction finance structure and professional support, you can focus on watching your dream home come to life while we handle the financial details.
Ready to start your building journey? Call one of our team or book an appointment at a time that works for you. Let's discuss how we can help you access the right construction loan for your project.
