Payout process - 6 steps
Unlike other types of home loans, construction loans are paid out in stages or as invoices come through. This can mitigate risk for the lender. It also ultimately makes it more cost effective for you as building delays won’t cost you extra in interest on an entire lump sum. There are typically six stages:
Preparation/Establishment: This includes the plans, council permits, connection fees, and insurances required for beginning work.
Base: Includes the concrete slab, footings, pad and base brickwork.
Frame: Money is loaned for the frame of the house i.e. the wooden bones that make up the shape of your home
Lock-Up: This step includes the windows and doors, roofing and roof tiles, exterior elements and insulation.
Fixtures and fitting: Think inside the home - this includes fitting out the kitchen with cupboards and appliances, plus the bathroom - shower, bath, sinks, toilet - and all plumbing and electrical work with power points and antenna outlets. This may also include plastering and painting inside.
Completion: The finishing touches are put on including any fencing around the yard, the site tidy up, and contractors receive their final payment.
Construction loan interest rates
You may have noticed interest rates on construction loans are higher than for established homes. It’s not uncommon to find construction loans 20-50 basis points higher than a regular P&I owner occupier home loan. This is because of four main reasons.
One, it’s paid in interest-only drawdown payments. Interest-only loans tend to attract higher interest rates.
Two, there is more risk for the lender where jobs aren’t completed on time or to budget. There could be material shortages, issues with tradespeople, inclement weather and other factors that can all blow out the cost of a home.
Three, there is technically no home to secure the loan against. Your lender will have to determine the home’s value and appropriate loan amount based on estimates of the dwelling’s value and land value estimates from the council.
And four, you won’t actually start chipping away at the principal home value until it’s completed - this enhances risk for a lender and heightens likelihood of negative equity (you owing more on the loan than the home is worth).
Building the home yourself - owner-builder mortgages
If you’ve seen Grand Designs or The Block and thought ‘I can do that’, then you’ll likely need what’s called an owner-builder mortgage. You will usually need a permit from the relevant state government body. Fines are applicable if you don’t.
In Queensland for example this is the QBCC, or Queensland Building and Construction Commission, and it’s applicable if you’re building anything worth more than $11,000. There are other limitations on work too, with these items ruled out (unless you're qualified):
Occupational work such as electrical work, plumbing, draining, gas-fitting or pest control
Fire protection or mechanical services work in excess of $1,100.
Build commercial or industrial buildings (e.g. shops, industrial sheds, farm buildings)
Removal of more than 10 square metres of asbestos
Build or renovate multiple dwellings (e.g. duplexes, attached granny flat, block of units).
Not all lenders offer or allow owner builder mortgages. This is because of the enhanced risk of getting a relative amateur to oversee all stages of construction. Further, owner builders are closer to the 'coal face' and are more closely tied emotionally and financially to the home.
Green construction loans
The past few years has seen the proliferation of green construction loans. That means homes designed and built with energy-saving features from the outset. Lenders will offer a discount on the home loan rate if the home you’re building is green, but there’s a few hoops you might need to jump through.
The most common stipulation is that the home must achieve 7-stars on the ‘NatHERS’ rating system. NatHERS stands for Nationwide House Energy Rating System. Tips on how to get to 7-stars can be found here.
Getting your home to a green standard means installing things like solar panels and batteries, double glazing your windows, having an optimal orientation and floor plan, and other environmentally-conscious construction items.
Documents needed for a construction loan
Beyond the usual documents required - proof of income, identification, and liabilities/assets, a construction loan requires a few more bits of paperwork.
Council plans and permits for construction
A fixed-priced contract
Your progressive payment schedule (if you plan on being an owner builder)