Buying a home
Everything you need to know about construction loans
8 October 2019
A construction loan can help you build your own home, finish a structural renovation or fund a rebuild project. But how exactly do they work, and how can you make the most of them? We spoke to a Suncorp lending expert about the basic workings of a construction loan, and got some top tips for first time borrowers.
Construction loans vs home loans: What’s the difference?
The first thing to know is that construction loans differ from other home loans. Many buyers choose to purchase an established property that doesn’t need extensive structural building or renovation. But if you’ve been dreaming of creating your ideal home from scratch, a construction loan may be the way to go.
Essentially, construction loans can be used to cover expenses when building your own home or making structural changes to a property, whereas regular home loans help fund the purchase of an existing property.
How do construction loans work?
Just as construction loans and other home loans have different purposes, both also have varying payment structures and loan requirements – from the deposit required through to the permissions needed.
Basic loan requirements
Unlike the pre-approval process for regular home loans, your approval for a construction loan is dependent on a few different steps and requirements. For example, you need to:
- Indicate whether you intend to build yourself or you want to select a licensed and insured builder (you must confirm that your chosen builder is qualified and insured).
- Ensure you have proper drawings of architectural plans, including any council permissions.
- Secure a signed and dated building contract including the estimated costs, terms of construction and progess payment schedule.
- Obtain the right types of insurance, including all builder’s risk and public liability insurance (usually up to $5 million).
- Value the structure ‘as if complete’, including the land value and proposed property valuation.
- Provide evidence of a 5% deposit of the estimated total cost for the build.
In addition to these requirements, you’ll also need to supply evidence of your income, expenses, assets and liabilities as you would with any home loan.
Instead of loaning you the lump sum all in one go, construction loans give portions of the loan in stages more commonly known as ‘progressive drawdown’ or ‘progress payments’.
These progress payments help to cover the costs of your home build at specific stages of construction. While every lender and build will have different outlines for these stages, a general rule of thumb to follow is:
- Deposit to your builder (eg commencement costs).
- Foundation (eg the slab, base and plumbing).
- Frame and brickwork (eg roofing and electrical fittings) .
- Lock up (eg windows, doors and insulation).
- Second fix (eg internal fittings and fixtures).
- Completion (eg conclusion of contracted items).
Once your construction loan is approved, your lender can help walk you through the details of your individual progress payment schedule. As your build progresses, your lender will also need to check in at each stage to make sure everything is meeting the expectations of the loan schedule. This includes the checking of invoices against work completed.
Making the most of construction loans
If used as intended, construction loans can provide you with the funds and flexibility to create your dream home.
As Head of Home Lending for various states, Jamie Brady has seen his fair share of construction projects and the loans that help fund them.
“We’re big proponents of responsible lending,” Mr Brady says. “As the Lending team with oversight across a number of states, our main driver is ensuring that all our customers are well-informed and empowered to make smart borrowing decisions that are right for them.”
“When customers have used progress payments as intended, they’ve experienced a greater sense of control over their build. Instead of providing the entire lump sum payment to a builder or developer upfront without surety of results, customers have seen great benefits in only paying for work that is complete, and signed off by us as well,” Mr Brady said.
“Our customers have also experienced construction loan success with reduced interest charges and repayments during construction. The nature of construction loans means that customers can benefit from the fact that interest is only charged on the amount drawn down, not the full approved amount – this can mean big interest savings in the long run.
“Similarly, construction loan repayments are generally lower. Since these loans are interest only, customers have experienced a greater freedom of cashflow during their construction period. If you’re still renting while building, any ease on your cashflow is welcome relief.
“Suncorp customers are also able to take advantage of our flexible loan structures – our construction loans allow borrowers to choose any available variable term loan product that best suits their build requirements and plan.”
Common pitfalls to avoid
While there are many advantages and good news stories about getting a construction loan, they can also come with their fair share of potential pitfalls. Jamie Brady has some sage advice to offer first time builders before they get cracking on their dream property.
“Construction loans work best when customers have a solid plan and employ the services of reliable professionals to help them realise it,” Mr Brady said.
“The lender oversight benefits that come with progress payments also have a potential flip side. Responsible lenders will only release funds for completed work when it’s up to the right standard and it meets the outlined terms of construction. This means if something on site isn’t up to scratch, you many not be able to pay your contractor until the work is completed to standard and as originally described in the plans.
“Along with funding issues, some customers have also run into trouble when their paperwork isn’t completed properly. Many customers underestimate the time and effort needed to secure the correct council approved building plans and fixed price building contracts. If this crucial paperwork isn’t obtained, it could mean extra costs outside of the approved loan amount.
“Every build is different and often filled with the unexpected. When the unexpected comes in the form of additional extras or upgrades, it can really catch a customer off guard. We’ve seen customers be tempted to go for upgraded fixtures and fittings, only to realise too late they’re outside of the original fixed price building contract. For those customers who chose to go ahead with the upgrades, they’ve needed to go through the process of obtaining updates to the original contract. If the new loan amount can’t be covered by the lender, it can mean the customer has had to pay for the extra expenses upfront – this can add up into the thousands.
“The best advice we can offer first time construction loan borrowers is to plan for what you can, do your research and surround yourself with the right people to help you realise the home you’ve imagined.”
Make the most of your construction loan
If you’re ready to build, we’re here to help you from the ground up.
Read more in the Home Buying Guide:
- What is a construction loan?
- How much do you (really) need for a house deposit?
- What influences how much I can borrow?
The information is intended to be of a general nature only. We do not accept any legal responsibility for any loss incurred as a result of reliance upon it – please make your own enquiries.
Any advice contained in this document has been prepared without taking into account your particular objectives, financial situation or needs. For that reason, before acting on the advice, you should consider the appropriateness of the advice having regard to your own objectives, financial situation and needs. Where the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should consider the Product Disclosure Statement before making any decision regarding the product. Contact us for a copy.
Home Loans are issued by Suncorp-Metway Ltd ABN 66 010 831 722 AFSL No 229882 Australian Credit Licence 229 882 (“Suncorp Bank”) to approved applicants only. Fees, charges, terms and conditions apply and are available on request.
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