Compare construction loan rates in January 2024

What is a construction loan?

If you want to build your own home on an empty block of land you'll need a construction loan rather than a normal home loan.

You can use a construction loan to cover the cost of both buying a block of land and the construction, or just the construction itself. With a construction loan your lender releases funds at each stage of the construction process rather than all of it upfront.

Construction loans tend to have higher interest rates. Borrowers also need to provide more paperwork to the lender to show they have a council-approved building plan and a fixed contract with a licensed builder.

How do construction loans work?

With a construction loan, your lender considers the total amount you need to borrow in order to pay your builder. Then it breaks down the full amount into separate payments called progress draws.

You receive a payment at the completion of each stage of the construction project rather than all at once. Repayments at this stage are usually interest-only. You don't start paying off the loan principal until the house is complete.

How do repayments work on a construction loan?

Construction loan repayments are interest-only during the construction stage. And you only pay interest on the money you've drawn on to cover the next construction stage.

This means you're not repaying the full loan amount until you've moved in to the house.

Once construction is complete, you start making principal-and-interest repayments on the loan. This is when you start repaying the debt plus interest.

The benefit of this repayment structure is that your repayments during construction are minimal, because you only pay interest on the money you've spent.

What kind of borrowers need a construction loan?

Constructions loans are a suitable mortgage for:

• Owner-occupiers buying land to build their own homes to live in
• Owner-occupiers building homes on land they already own
• Existing home owners looking to make substantial renovations
• Investors looking to build a new investment property

How to apply for construction finance

Getting a construction loan approved takes a bit more paperwork than other home loans. Here's a rough outline of the process:

1. Start by comparing construction loan rates from multiple lenders (see the table above) to get a competitive deal.
2. Work out roughly how much you can afford to borrow for your construction loan, based on your income.
3. Make sure you have evidence of your income and expenses, a detailed building plan (with council approval), a contract from a licensed builder and proof that your builder has the necessary builder's insurance.
4. You can usually apply for a construction loan on your chosen lender's website, or potentially over the phone or in a branch.
5. The lender will examine all your documents and conduct a land valuation before (hopefully) approving your loan.
6. Once approved, construction can begin and your lender will release funds as needed (according to the agreed-upon building plan).

Construction loan contracts are a bit more complicated than other loan contracts. With any property transaction, you should always have an expert solicitor or conveyancer review any contracts before you sign them.

Understanding the 5 steps of a construction loan

With construction loans, funds are paid in stages known as progress draws. These stages correspond to the progress of your home's construction. They can vary a little depending on your builder and lender, but generally are as follows:

1. Foundations and footings

• The building site is cleared of any vegetation and debris, and is levelled. Footings for your house are installed and spaces are cut out for the site's plumbing.
• During this time, the concrete slab for your house will be poured. After this, initial plumbing and waterproofing will be installed.

2. Frame-up and brickwork

• The framework, trusses, roof and windows will be constructed. If your home has brickwork, this will be partially done.
• Gutters and insulation will also go in at this stage, as will any conduits for plumbing or electrical work.
• At the completion of this stage, the second progress payment will be made.

3. Lock-up stage

• During the lock-up stage of construction, doors and windows will be installed. All exterior walls will also be completed.
• At the end of the lock-up stage, your home will be sealed and protected from the elements.
• Your lender will make the third progress draw payment to your builder. This is one of the most significant drawdowns, often making up 20–35% of the total building funds.

4. Fit-out

• At the fit-out stage of construction, all fixtures, fittings and appliances will be added.
• Plumbing and electrical work is completed, gutters and downpipes are installed, skirting boards, cornices and architraves are added, kitchen benches and cupboards are put in and shower screens, mirrors, sinks, toilets and faucets are installed.
• At the end of this stage, your lender will make the fourth progress payment to your builder.

5. Practical completion

• Your home is almost finished. Your builder will work on the finishing touches, including painting, any final electrical or plumbing work, final installations of appliances and any other detailing.
• At the end of this stage, which can take up to 8 weeks, you'll do a final walkthrough of your property to identify any problems, and the builder will walk you through the property's features.
• Your lender will also do a final inspection before disbursing the final progress drawdown. After this stage, your construction home loan will also be converted into a traditional home loan.

The pros and cons of construction loans

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Frequently asked questions

• How much time do I have to construct my home?

  Most construction loans give you up to 2 years to finish the construction of a new home. If you’ve purchased your vacant block of land as part of your construction loan, the time frame commences after your land purchase has settled.

• Can I add external quotes to my construction loan?

  There are times when you may want to include quotes from external contractors who aren’t with your builder as part of your total mortgage. This might include quotes for air conditioning, floor coverings, driveways or pergolas to be added. Some banks will allow you to add individual quotes to your building pack or bank pack that your builder gave you, which lets you include those things in your mortgage amount. The progress draw payments remain the same to your builder, but the payment for those external quotes won’t happen until after the builder has been paid first and your house is at practical completion stage.

• What happens if my building costs go up?

  Most builders try to offer "fixed price" contracts. While the cost of your new home construction won't change after this has been fixed for you, always be very wary of "variations" added to your final costs by the builder. These can include changes in the footings/foundation price after soil testing has been conducted.

  If your contract includes a "TBA" or "NC" item listed anywhere, ask for verification about this. These are the builder's way of saying that your house price might be fixed, but there might be things that can change in cost that they won't guarantee.

  Price increases can also include any upgrades you may have made during your colour selections process. This is when you arrive at various suppliers to choose your tiles, paint, bricks, roofing and other items that go into your house. Your building contract will include an allocation to cover these things, but if you spend more than you intended, your costs will go up.

  Most banks are quite understanding about this and will expect that all those final variations have been received by the time your finance approval is underway. If there are any changes in pricing after this time, you may have to alert the bank to account for the extra, or you'll need to pay for them yourself.

• What percentage of the building costs am I able to borrow?

  Most banks and lenders will let you borrow up to 95% of the value of the land plus the construction costs. Note that this doesn’t say "95% of market value", as it would if you were buying an established home. Instead, banks use a "To be erected", or TBE valuation to determine what percentage of your costs you can borrow.

  This means the bank will use the actual market value of your land, or the purchase price shown on the purchase contract, whichever is lower. Then it will add the exact cost of your construction to your land value to arrive at a TBE valuation amount.

  This is not the same as the market value of your property once the construction has been completed. If you’re careful with your spending, it could be possible to pay less money constructing your home than it is actually worth in market value once it’s completed. If this is the case, it is very possible to have your newly built home re-valued 3 months after completion to maximise your equity. This is ideal if you intend to refinance after construction is finished to help pay for finishing touches to your home.

• Can I get an interest-only construction loan?

  Yes, you can. In fact, almost all construction loans are set to interest-only payments during the progress draws period. Only after the construction is complete and the final drawdown payment has been made will your loan revert to a full principal and interest payment, unless you specifically request for it to stay on interest-only payments.

• Can I make extra payments during the progress draw period?

  Most banks will allow you to make extra payments off your mortgage while your loan is still in the progress draws stage. Some banks will even let you link a 100% offset account to your mortgage account while it’s still being drawn down. This helps you get ahead on your mortgage while the balance is still low and reduces how much interest you’ll pay overall. Always check with your bank that they’ll allow this.

  Building your own home can mean you get everything exactly the way you want it and with a construction loan you remain in control of the building process at every stage.

• Can I get pre-approval on a construction loan?

  Many lenders offer pre-approval for construction loans. While it's not the same as full approval, you can get some confidence around how much you can borrow. You can get pre-approval before you have a contract with a builder of council-approved plans.

• Can I get a construction loan with a low deposit?

  While some construction loan lenders will require at least a 20% deposit - sometimes more - there are options out there for a higher LVR. If you are planning to build your first home you may still be eligible for government schemes like the First Home Loan Deposit Scheme.