Construction Loans Inside Out for Potential New Home Owner Occupier
Some might argue that Construction Loan is the best way to get into the property market for potential first-time owner occupier home buyers simply because you save hips on your home loan interest repayment while building your dream home.
What is a construction loan?
When you build your brand new home from scratch you need a construction loan. Your construction loan can be set up in such a way where you may be able to buy a vacant land first and then arrange to build on that land within a set period of time. It can also be very suitable for people considering a major renovation on their existing properties.
The biggest advantage for savvy home buyers to consider construction loan because you can draw out the amount needed for various stages of the construction of your house, therefore, you save money by only paying interest on borrowed amount while your dream house gets built.
You can also choose to opt for interest only option for first two years period of the construction loan. That way, you can maintain your rent and your construction loan repayment without any financial stress
The lenders require a lot more information for construction loan such as council approved plans, builder tender etc so it generally takes more time to organise a construction loan. The LVR is also usually higher in constructions loans. So you would need higher deposit for your land for lenders to consider giving you a construction loan. The interest rate is usually a little higher for construction loan and though it usually reverts back to standard rate once the construction of your new home is completed.
Things to know when considering construction of your new residence
The consumer affairs department in each Australian state has set out guidelines for builders to carry out the home construction in stages. Therefore you need to make sure you only pay for each stage rather than tricked into paying more than you have to. The building of a new house generally has six stages and your construction loan can follow suit.
If you have borrowed to purchase land and are looking to obtain a construction loan, most lenders will estimate the value of the completed package based on the value of the land plus the cost of the building materials for the residence.
For example, if your land has been purchased for $350,000, and the cost to build was estimated at $300,000, the lender would put the total value of the house and land at $650,000. An identical ‘completed’ house on an identical piece of land next door to you may be worth $700,000.
Most lenders will normally lend only around 60-65% of the land value for purchase as a land loan. Some lenders are however lending up to as high as 90-95% of the land value, so check with your mortgage broker how much you can borrow.
Here is an example how it applies to a typical construction loan when building your home. Consider you have put down a 5% deposit on your land.
Land – Land Loan: Buy the piece of land where you are going to build your new house.
Floor – 10% Cost: Get the ground and floor ready. i.e. Concrete or wooden
Roof – 15% Cost: Get the roof ready usually with frames
Lock up – 35% Cost: When the door and the windows are fitted and the house can be secured
Touch up – 20% Cost: When all the amenities in the house such as kitchens, bathrooms, toilets, cabinets etc. are fitted according to the contract.
Finishing – 15% Cost: All features are installed and inspected according to the building contract. The new residence cleaned and ready to move in.
With a construction loan, you can break up the entire construction loan amount into five draws and pay the builder only when one phase has been completed and the next phase is about to start. This means you are only making repayments on the portion you have used.
Requirements from Lenders
When you decide to build and apply for a construction loan, the lenders will need to see, at a minimum, council approved plans and a fixed price building contract, before they will unconditionally approve a construction loan.
If you need to borrow more funds for improvements such as landscaping, you may be able to get your property revalued by your lender once the building is complete.
After each phase is finished, a valuer will normally go out to inspect it to make sure that the phase is complete according to the requirements set out in the fixed price building contract. Once the valuer is satisfied, they will contact the lender and authorise the next payment.
Features to cover your unseen construction costs
If you are concerned that you may need to pay contractors before the set phases are done, you may want to consider obtaining a very small line of credit as part of the loan. That way, you will be able to pay any urgent bills from the line of credit before the appropriate phase is complete, and then pay your line of credit balance to zero from the construction loan, once the relevant phase is complete and the money has been drawn down.
To ease the financial burden during the construction phase, construction loans are usually interest-only. The interest rate may be slightly higher than that charged on normal residential loans but should be less than that of a line of credit/equity rate.
The Construction Loan Checklist
Most construction finance applications are assessed according to the standard process and many of the same documents are required, along with a fully completed ‘build pack’ (or ‘Bank Pack’) which includes:
Signed fixed price building contract between borrower and a licensed builder Tender
Stamped, council approved building plans
Copy of builder’s insurance policy must-have features
Interest-only repayments during construction and a switch to principle and interest repayments thereafter
The ability to make extra repayments
Flexibility – including redraw during the construction period. Will you able to switch to a more flexible product upon completion of construction? Some lenders offer a 100% offset account linked to the home loan, which is a handy feature as it allows you to save on interest by parking any cash to this account
You are paying less interest on the loan because interest is calculated on the outstanding balance, not the maximum loan amount which has been agreed to.
For example, if the lender has agreed to lend you $600,000 but you have only drawn down $250,000 to pay for the land and $50,000 as an initial payment to the builder at this point, you are only charged interest on $300,000, not $600,000.
During construction, your loan repayments are usually interest-only, payable only the amount of the loan that has been drawn out, which means lower repayments.
Peace of mind
The fact that payment is delivered to the builder in stages means that cash is not paid out until the builder’s work is inspected and approved by the borrower.
The borrower can borrow against the value of the property as if it were completed, as opposed to borrowing only against the value of the land or the current property. This saves the borrower time and money in terms of going back for more cash in case the fund runs out during construction.
Golden Key Mortgage Brokers can help you with your construction loans and land loans if bought separately without a package. We are your expert mortgage brokers in Sydney and surrounds.