Building or Renovating? A guide to construction loans

Limited travel opportunities, a huge uptick in savings¹ and more time spent at home over the last 12 months has meant that an increasing number of people are currently looking at remodelling, or even rebuilding, their home.

Undertaking major renovations can be challenging and complicated, but the finance to enable it doesn't need to be. Construction loans are designed to make financing a build or major renovation as straightforward and stress-free as possible.

With that said, there are a few things you need to know before you apply for a construction loan and start your build.

How construction loans work

The main difference between construction loans and normal home loans is the way they're structured:

• With a regular home loan, you will usually receive the entire loan amount in a lump sum on settlement day to purchase your chosen property.
• With a construction loan, you'll generally withdraw loan funds in installments to pay for progress made at each stage of construction. This is called 'progressive drawdown'.

In most cases, you'll only pay interest on the amount of the loan you've drawn down, or used, so far. For example, if you've been approved for up to $200,000 for a build but you've only drawn down $25,000 so far, you'll only be charged interest on the $25,000 portion.

Depending on which lender you borrow from, you may only be required to make interest payments until construction is complete. This can make it easier to make repayments during the build when you may be incurring a number of expenses.

How to apply for a construction loan

To apply for a construction loan, you'll need to supply your lender with all the usual documentation such as identification and proof of income, expenses and investments.

You may also need to provide some additional documentation concerning the construction of your property, including:

• A copy of the building contract (including all variations), between you and the builder in relation to construction (including a copy of the builder's license)
• A copy of the plans and specifications approved by the relevant authority in relation to construction
• Quotes for any work not being completed by the builder (eg, Driveways, Fencing and Landscaping)
• Homeowners warranty insurance
• A builders all risk policy and a certificate of currency for that insurance

In some cases, you may also be required to get a valuation that estimates the likely value of your property once it's complete. This ensures that the total amount that you're borrowing won't exceed the value of the build once it's complete.

The stages of your construction loan

In your building contract, your builder will outline the cost of construction. The total cost will usually be split into five segments to be paid at key stages of the build.

It's important to have a discussion with your builder and review the contract and specifications to ensure you understand what is included (or excluded) from the contract. There are often requirements from councils before you take possession of the property, for items that the builder may not have included. Some examples of these items are: Flooring, Driveways, Landscaping and some appliances. In these cases you will also need to obtain quotes for these to provide to your lender.

As each stage is finished, you'll generally need to send an invoice from your builder to your lender in order to draw down on your loan. The stages or segments are usually:

1. Slab down
Building the foundations of your property including ground works and plumbing.

2. Frame
Building the frame of your property including construction of trusses, roofing and window frames.

3. Lock up
This phase of the build includes all elements required to lock up the property. That usually covers construction of external walls, installation of doors and windows.

4. Fit out
Installation of fittings such as cabinetry and shelving, taps and sinks, tiles and internal doors.

5. Completion
This stage of the build encompasses everything that's required to complete construction. That might include painting, cleaning and fixing any minor issues.

Once construction is completed and any interest-only period ends, your loan will revert generally to a normal home loan structure. That means you'll be required to make monthly principal and interest repayments, just as you would with a regular mortgage.

Getting the keys to your new home

Before the final payment can be made to your builder so you can receive the keys to your new home there are a few things that need to be completed.

Home Insurance:

You'll need to get home insurance over your property.  When your property was valued by the bank the was also a notification of the minimum insurance you must carry on the property.  This will need to be provided to the Bank.

Occupancy Certificate:

Depending on your state you may need to provide an occupancy certificate or other certification.  For example, in NSW this is provided to you to confirm that the property has been built per the approved plans, is of sound construction and that the property is readily habitable.  This includes completions like boundary fencing, basic landscaping and often driveways that are often not part of the builders' works.  You will need to ensure you arrange with your builder to have these completed and these trades have access to the site.  If these items are not completed you may not be able to obtain this certificate.

Once these are provided the “Completion” Payment can be made to your builder and you're ready to move in.

Government grants for building a home

A construction loan isn't the only way to finance a new build or substantial renovation. In fact, you may be able to receive a government grant to contribute towards your project.

First Home Owner Grant

Most Australian states offer first home buyers a 'First Home Owner Grant' to buy or build a new home. To be eligible for the $10,000 grant in NSW, you must meet certain criteria including (but not limited to):

• The value of the land and property once completed must be less than $750,000.
• You must have never owned a home in Australia or received the grant before.
• Plan to move into the property within 12 months of completion and live there continuously for at least 6 months.

To check eligibility and find out how to apply for the grant, visit your local state revenue office's website.

If you're planning on building your dream home, an investment property, or making structural changes to your current home, we'd love to help. Learn more about our construction loans, use our handy calculator to see how much you could borrow and apply directly online here.