How Do Construction Loans Work?

If you're in the market for a new home, there's a good chance you'll need to take out a construction loan. These loans are unique in that they allow you to borrow money specifically for the purpose of building or renovating a home. But how do they work, and what should you expect? In this blog post, we'll provide an overview of how construction loans work, including the different types available and how to apply.

How Do Construction Loans Work Table of Contents

What is a Construction Loan & How Do Construction Loans Work?

What Are Standard Construction Loans?

What Are Owner Builder Construction Loans?

How to Apply for a Construction Loan

How Quickly Can You Get Money From a Construction Loan?

What Are The Average Interest Rates of a Construction Loan?

What Are The Risks of Taking Out a Construction Loan?

What Are The Eligibility Requirements for Construction Loans?

What Are The Different Types Interest Rates on Construction Loans?

Standard Variable Rate (SVR) Home Loan

Fixed Rate Home Loan

How Do Construction Loans Differ From Regular Home Loans?

What Are The Fees Associated With Construction Loans?

What is a Qualified Builder for a Construction Loan?

How Much of a Down Payment Do I Need For a Construction Loan?

What Is The Maximum Loan Amount With a Construction Loan?

Can I Refinance My Construction Loan?

How Do I Apply For a Construction Loan?

What is a Construction Loan & How Do Construction Loans Work?

A construction loan is a type of short-term loan that helps you finance the construction of a new home or renovation. Construction loans are typically used when you're self-building or renovating, and they can be either secured or unsecured.

There are two main types of construction loans:

• Standard Construction Loans
• Owner Builder (self-build) Construction Loans

What Are Standard Construction Loans?

A standard construction loan is a short-term loan that's used to finance the building or renovation of a home. These loans are typically interest-only, meaning you only have to pay the interest on the loan during the construction period. Once the project is complete, you'll then need to pay off the entire loan amount. Standard construction loans usually have terms of 12 months or less.

What Are Owner Builder Construction Loans?

An owner builder construction loan is a loan that's specifically designed for people who are building their own home. These loans often have longer terms, and you may be able to make interest-only payments during the construction period. Owner builder construction loans can also be used to finance renovations.

How to Apply for a Construction Loan

If you're interested in applying for a construction loan, there are a few things you'll need to do:

• Find a lender: You'll need to find a lender that offers construction loans. Not all lenders offer these types of loans, so it's important to shop around and compare your options.
• Get pre-approved: Once you've found a lender, you'll need to get pre-approved for the loan. This means providing the lender with information about your income, assets, and employment history.
• Find a builder: If you're not already working with a builder, you'll need to find one that's willing to work with you on your construction project.
• Draw up plans: Once you've found a builder, you'll need to draw up plans for your project. These plans will be used by the lender to assess how much money you'll need to borrow.

Construction loans can be a great option if you're looking to finance the construction of a new home or renovation.

How Quickly Can You Get Money From a Construction Loan?

The amount of time it takes to get money from a construction loan will vary depending on the lender and the type of loan you're taking out. Standard construction loans are typically disbursed in instalments, while owner builder loans may be paid out in one lump sum.

It's important to keep in mind that construction loans are typically interest-only, so you'll only have to make payments on the interest during the construction period. Once the project is complete, you'll then need to pay off the entire loan amount.

How Much Does a Construction Loan Cost?

Construction loans typically come with higher interest rates than other types of loans because they're considered to be riskier. However, how much you'll pay in interest will depend on the lender and the type of loan you're taking out.

It's also important to keep in mind that construction loans are typically short-term loans, so you may have to pay fees for taking out the loan. These fees can add up, so it's important to compare your options and choose a lender that offers competitive rates.

What Are The Average Interest Rates of a Construction Loan?

Interest rates on construction loans vary depending on the lender and the type of loan you're taking out. However, construction loans typically have higher interest rates than other types of loans because they're seen as riskier.

It's important to compare your options and choose a lender that offers competitive rates. You should also make sure to factor in any fees you'll be charged for taking out the loan.

What Are The Risks of Taking Out a Construction Loan?

Taking out a construction loan is a big decision, and it's important to understand the risks before you commit. Here are some things to keep in mind:

• Construction loans are typically interest-only, so you'll only have to make payments on the interest during the construction period. Once the project is complete, you'll then need to pay off the entire loan amount.
• Construction loans are typically short-term loans, so you may have to pay fees for taking out the loan. These fees can add up, so it's important to compare your options and choose a lender that offers competitive rates.
• Construction projects can be unpredictable, so there's always a risk that you could end up spending more money than you expected. This is why it's important to work with a reputable builder and get accurate estimates before taking out a loan.

What Are The Eligibility Requirements for Construction Loans?

Construction loans are available to both owner-occupiers and investors, although the eligibility criteria will differ between lenders.

For an owner-occupied construction loan, you’ll typically need to have a deposit of at least 20% of the property value, as well as a good credit history.

If you’re applying for an investment construction loan, the requirements may be stricter, with some lenders requiring a deposit of 30% or more.

In either case, it’s important to remember that the final loan amount cannot exceed 80% of the post-completion value of the property (or 70% if you’re planning on refinancing).

What Are The Different Types Interest Rates on Construction Loans?

There are two main types of construction loans Interest Rates:

Standard Variable Rate (SVR) Home Loan

With an SVR loan, the interest rate will fluctuate in line with market conditions. This type of loan is best suited to those who are planning on selling the property within a few years, as you’ll be able to take advantage of any decreases in the market rate.

Fixed Rate Home Loan

As the name suggests, a fixed rate loan has an interest rate that remains constant for the life of the loan. This makes budgeting easier, as you’ll know exactly how much your repayments will be each month.

How Do Construction Loans Differ From Regular Home Loans?

Construction loans differ from regular home loans in a number of ways:

• They have a shorter loan term: Construction loans are typically paid out in stages, so the loan term is usually much shorter than a standard home loan (usually around 12 months).
• They have higher interest rates: Construction loans also tend to have higher interest rates than regular home loans, as they are considered to be higher risk.
• They require progress payments: With a construction loan, you will need to make progress payments to your builder or developer as work on the property progresses. These payments are usually made every month or two, and can be rolled into the final loan amount.
• They require security: In most cases, you will need to provide security for a construction loan in the form of a registered mortgage over the property.

What Are The Fees Associated With Construction Loans?

There are a few fees that you need to be aware of when taking out a construction loan:

Application Fee

This is a one-off fee charged by the lender when you first apply for the loan.

Valuation Fee

The lender will need to have the property valued to assess how much they are willing to lend you. This usually costs around $200-$300.

Drawdown Fees

These are fees charged each time you draw down funds from your loan account (usually at regular intervals as work on the property progresses). They can either be a flat fee or a percentage of the amount drawn down.

Discharge Fees

When you finish making repayments on your loan, you will need to pay a discharge fee to have the mortgage registered in your name (if you are an owner-occupier) or removed from the title (if you are an investor). This usually costs around $300-$400.

What is a Qualified Builder for a Construction Loan?

Most lenders will require you to use a qualified builder when taking out a construction loan. A qualified builder is someone who:

• Holds a current builders licence in the state or territory where the property is being constructed.
• Has been registered with the local building authority for at least two years.
• Has completed an accredited training course in home construction (this requirement may vary between states and territories).
• Is a member of an industry body such as the Master Builders Association or the Housing Industry Association.

How Much of a Down Payment Do I Need For a Construction Loan?

The amount you will need to put down as a deposit for a construction loan depends on the lender you use, but it is typically around 20% of the purchase price of the property.

What Is The Maximum Loan Amount With a Construction Loan?

Most lenders will cap the loan amount at 80-90% of the property value, including the land value and the construction costs.

Can I Refinance My Construction Loan?

Yes, you can refinance your construction loan once the construction is complete and you have moved into the property. You will need to apply for a standard home loan with a new lender, and your existing lender will usually require you to pay out the remaining balance of your construction loan before they release the mortgage.

How Do I Apply For a Construction Loan?

You can apply for a construction loan through your bank or credit union, or through a specialist construction lending institution. When applying for a loan, you will need to provide:

Proof Of Income

This can be in the form of payslips, tax returns or financial statements from self-employed applicants.

Evidence Of Savings

The lender will want to see evidence that you have saved enough money for the deposit and other associated costs (such as stamp duty).

A Detailed Construction Budget

This should be prepared by your builder or developer and outline all the costs associated with the construction of the property.

A Contract Of Sale

If you are buying an off-the-plan property, you will need to provide a copy of the contract of sale.

Property Plans And Specifications

The lender will need to see detailed plans and specifications for the property in order to assess how much they are willing to lend you.

If you are planning on building a new home or investment property, it's important that you understand how construction loans work. With this guide, you should now have a good idea of what they are, how they differ from regular home loans, and what fees.