Why are construction loans so complicated?

Building a home is a complex process that involves multiple parties including builders, contractors, lenders, solicitors, accountants, quantity surveyors and the council.

With so many people involved in the process, there’s always the possibility of a communication breakdown and things may go wrong.

Getting approved for a building loan is half the battle with the majority of mortgage brokers and bank employees not understanding the process. Check out this guide for golden tips.

Accept the reality and set your expectations

Each lender processes a loan in a particular manner. With a conventional loan, it’s often easy to have the loan submitted and approved in a timely manner.

For a construction loan, this system is often poorly-designed and run by inexperienced staff within the banks.

Loan documents are commonly lost and credit officers often lack communication skills, leading to misunderstandings and delays.

Our job as your mortgage broker is to fix these issues as they arise and, where possible, prevent them from occurring in the first place.

No matter which lender you apply with, you’ll need to have some patience!

As a result, construction loans are often set-up with many errors. The loan amount may be incorrect or it may be delayed, due to constant amendments.

How do construction loans work?

When you apply for a loan, the lender will need a copy of the building contract/tender and the plans.

They’ll ask their valuer to estimate the on-completion value of the property and will assess your loan on the lesser of the land price plus the cost of construction or the on-completion value.

Once your loan has been approved, the lender will issue a loan offer for you to sign and return, just like with any other home loan.

When your builder is ready to begin receiving payments from the bank, he’ll need to provide additional documents, such as the final council-approved plans, his insurance and drawdown schedule.

How do you request that the bank pay your builder directly?

  • The builder will send you an invoice.
  • You’ll then complete and sign a drawdown request form (available from your lender).
  • Send the drawdown request form and the invoice to the construction department of your lender.
  • The lender may require a valuation to confirm the work that has been completed so far.
  • The funds will be advanced to your builder generally within five working days.
  • Repeat this process for each progress payment required by the builder.

Check out the stages of construction page for more information.

Changes to the building contract

Did you know that if you make an amendment with the builder and the contract price changes by just $100, the lender may need to reassess the loan all over again?

So how can you avoid changes causing a problem with your home loan?

  • Make sure that the building contract you provide the lender with is the final complete contract.
  • If you make any small changes then try to pay for them from your own funds or have the builder reimburse you for any discounts after construction is complete.
  • For any large changes, you’ll need to notify the bank and then allow up to one month for the bank to reassess your loan.
  • “Keep it simple” works very well with the banks! If you keep making changes then expect to have significant delays.

Other minor quotes

It’s quite common for people to hire contractors to complete other work such as landscaping, utility connections, swimming pools or site works.

Try and get all of these minor quotes included in the building contract and then have the builder pay for them.

This may not work for the builder so discuss this with us and your builder before deciding on the best way to go.

Sometimes the banks will only release funds for other quotes on completion of construction.

Be careful because you may have agreed to pay the contractor up front!

One loan or two?

If you’re buying the land, you may want to consider splitting the loan into a “land loan” and “construction loan”, which means that they’ll be advanced at different times.

If this isn’t done then you’ll need to put all of your required funds in at the time the land settles.

Any LMI will be charged at land settlement.

Your broker will discuss this with the lender to confirm their process and find out when you’ll be required to contribute your deposit.

Please call us on 1300 889 743 or free assessment form and one of our mortgage brokers will work out the best way to structure your loan.

How big of a deposit do I need?

Most people go over budget!

We recommend that you keep saving during the construction process and try to avoid any large expenses until construction is complete.

As a general rule, we try to ensure that you get approval for a slightly higher loan amount.

This is to ensure that there are plenty of funds available.

There’s nothing worse than running out of funds when your house is almost complete!

If you’re borrowing 100% of the cost of land and construction with a family pledge home loan (guarantor loan), then you’ll still need some funds on standby to allow the builder to create the building contract and apply for council approval.

This is because the lender can’t release funds outside of the specified construction drawdowns.

Additional work completed by contractors

In some cases, part of the work isn’t being completed by your builder.

Some common examples are:

  • Swimming pool
  • Pergola
  • Driveway
  • Power pole / power connection
  • Landscaping
  • Site clearing
  • Shed, dam or other hobby farm improvements

If you can provide a formal written quote for this work then we can often get the bank to extend the loan for these costs.

It really depends on the nature of the work and the lender that we’re working with as to whether this will be possible or not.

The key is to give us this information at the beginning of the process!

If you tell us about the additional work later on then we can’t get the lender to finance it.

Be careful as some lenders will only release money for the additional work once the main house is completed.

This may not suit your construction schedule so, in some cases, we need to change to another lender.

Are you paying cash?

If your builder is being paid cash for their work then no lender can approve a construction loan for you.

They can only approve a loan based on the current value of your property.

We recommend that you always sign a formal contract with your builder, ensure they have the correct insurances in place and follow all relevant state and federal legislation.

First Home Owners Grant

The First Home Owners Grant (FHOG) is paid to the lender by the government when the first drawdown is made to the builder.

This means that many people who were borrowing a high percentage of the property value may have enough funds to complete the project but may not have enough to settle on the purchase of the land.

Each state and territory has their own incentives for both first home buyers and those building homes.

This is particularly true in recent years where expontential growth in the real estate market has forced federal and state governments to review their first home buyer grants and concessions.

We recommend that you contact your state government to confirm the incentives that you may be eligible for (you can find a link to state revenue offices on the FHOG guide page).

We’ll always complete a “funds to complete calculation” for the land and for the total project to make sure you have enough money to complete both stages.

Guarantor loans

The combination of a with a construction loan is particularly difficult to organise.

Most lending systems simply can’t handle this combination and as a result there are delays and errors.

Please discuss this with us as we have a couple of lenders that can accept this type of loan set up!

Do I need a building certificate?

The council should be approving the construction before work even commences.

It’s when buying a property that has been renovated that you should ask whether the owners (vendors) can provide a copy of the building certificate.

In that way, you can ensure the renovations were to code and you avoid the risk of council fines.

If you’re an owner builder, you’ll need to apply for Development Approval (DA) with the local council.

Cost plus / variable cost construction loans

In some cases, you may not be able to determine the total cost of construction before your loan is approved so you can apply for a Cost plus / variable cost construction loan.

This type of loan is based on the plans for any property purchased for the purpose of building, renovating, knocking down or rebuilding.

We are construction loan specialists!

Our mortgage brokers are specialists in construction loans.

We can quickly work out which lenders can approve your loan.

In addition to this, we can structure your loan in a way that ensures that your new home is built without the hassles.

Please call us on 1300 889 743 or fill in our free assessment form and one of our mortgage brokers will assist you in getting approval for a construction loan.

  • Abbaabdi

    I want to build a house knocking dawon current house which has under $ 300,000 loan init would it be possible to borrow from bank for construction to build new house?

  • Hi Abbaabdi,
    Yes this is possbile as long as the land is worth significantly more than $300,000. If you knock down the house then how much do you think the land would be worth? Also how much would you like to spend on construction?

  • Abbaabdi

    Thanks for replay.
    I don’t know but if you know My property located in St Alban VIC 3021 and I am thinking to bring down current loan amount to $200,000 I believe the land will worth much more than this however I am thinking to build 4 bead room single store even No idea how much roughly cost to build a house.

  • Ok that should be fine. If you’d like our assistance then please call 1300889743 and ask for Tim or Raul who are experts in construction loans.

  • Jamie

    I’m wishing to knockdown and rebuild current home to build a new home. I still have $150,000 owing on mortgage. Valuation was done by bank this week and the land was valued at $280,000. We’re looking at a build budget of $415,000 for build, landscaping, demolition, retaining walls. Is it possible to do this? We have 2 dependants, 2 applicants (married) income of person 1 $2000 per f/n net, person 2 $550 per week net. Average expenditure, no other loans and 1 credit card.

  • Hi Jamie,

    From a valuation point of view yes this is feasible. From an income and affordability point of view we’d need to complete a full assessment to be sure. If you’d like our assistance then please call us on 1300 889 743 and one of our mortgage brokers can make a recommendation including your bank as well as others that are good at construction loans or that are the cheapest depending on your requirements.
    Best of luck with your project.

  • Teddy

    I’m going to buy an off-the-plan house (land and build) from my neighbour before the land settlement. The cost in total including land and build is $790,000. I have saving of $190,000, a permanent job with an annual income of $100,000 and a paid off property which is valuated at $800,000. Based on the information, it is likely for me to get a construction loan for 80% of the off-the-plan house? I heard that I can also borrow a normal standard home loan which has lower interest rate. Can you provide some advice?

  • Hi Teddy,
    Yes you appear to be eligible for the loan assuming one property is rented out and your living expenses and other debts are low. We’d need to do a full assessment to be sure.
    It’s a possibility that you could get a standard loan not a construction loan. However we can’t be sure of this without doing a full assessment. It’s likely that using your existing property we can get you a low rate loan to use to fund the new property. I’ll email you and cc one of our specialists in this area who can assist you further.

  • Katrina Pearce

    Hi guys
    My partner and I are looking at building our first home with a project home builder. They require 10% of the land cost upfront (land approx $300k) and 5% of the construction cost (approx $300k). The land will settle in September 2018 (some six months later). What sort of loan would we obtain and would we need to come up with two deposits I.e one for the project home builder and one for the bank.
    Would we need to make repayments straight away.
    Tanks for your help.

  • Hi Katrina,
    Firstly this is an off the plan purchase of land so there are some risks involved. You are committing to buy the land now but the banks won’t commit to lend to you until 3 months before settlement. If the valuation comes in low or your situation changes (e.g. change jobs) then you may be unable to get approval. So I’d only recommend that you buy if you’re in a strong financial position.
    You can get a preapproval now but it will expire before settlement so isn’t worth too much.
    Yes you need 10% now and 5% for the build. However the first home owners grant (if applicable) can form part of your 5%.
    You only make repayments once the land has settled.
    Hope that helps, good luck!

  • CB

    Hi there,
    Just wondering if we have already purchased a block of land (we paid outright 55% of purchase price, with a small mortgage for the remainder) and would like to start building. We currently live in a major city and our land is located some distance away in the coastal areas. We still have a substantial amount of cash savings, as we qualify for the NSW FHOG in order to obtain leanding to complete the build do we need to relocate to the area to qualify for a loan otherwise will we be required to lend as investors? Just thinking if we could save $ by not having to relocate and then rent etc.

  • Hi CB
    You can build the property now while living in Sydney. As for if it is a home loan or investment loan it’s best to discuss with your mortgage broker. Some lenders will decline a home loan saying that if you’re moving into the property then you’re leaving your job. An investment loan would have a higher rate however most lenders allow you to switch to home loan rates if you provide evidence later on that you’re living in the property. So you may pay a higher rate during the construction period but after that you would be ok.
    Good luck with your move! We’ve had a lot of customers do a seachange out of Sydney and they’ve all loved it. Nobody has moved back.

  • Joshua Oldfield

    Hello, we have committed to purchasing a block of land (off the plan, settles in late August 2018) We paid the 10% deposit of 46,000 on the $460,000 lot over a year ago. We have pre-approval for the land loan with a 20% Deposit. Once we own and are paying off the land will we be able to get a construction loan with a lower percentage deposit? say 5% or 10%?

  • Hi Joshua
    Let’s say you settle the land with a loan for 80% of the property value. When you go for construction let’s say it costs $540,000 making a total cost of $1,000,000. You can borrow up to 90% or 95% with most lenders which means $950,000 or $900,000. After considering your loan for 80% of $460,000 ($368,000) this would mean your loan could be increased by over $582,000 which is sufficient to pay for construction.
    To cut a long story short you can likely build without putting in any additional money. If you have additional funds it’s best to put them in as this will reduce the cost of LMI.
    Also make sure you keep some funds on standby! Construction almost always goes over budget.
    Best of luck with your build and if you would like a 2nd opinion on your loan then feel free to call us on 1300 889 743.

  • Hi Sam,

    1. Yes, if you can provide a formal written quote for this work then we can often get the bank to extend the loan for these costs.

    The key is to give us this information at the beginning of the process not after you have applied for a construction loan.

    It also depends on the lender and whether they will accept this work and offer you the finance to fund it.

    2. No, you can apply with a different lender for the construction loan component. You just need to show proof that you hold the title for the vacant land.

  • Emma

    Hi there our bank has approved our construction loan. The builder is not providing the required information within the building contract. The bank has deemed the builder high risk and won’t approve the building contract.
    I have paid $10k for the plans and council approval. Should The builder refund my $10k as they are at fault not me? Thanks Emma

  • Benn

    Hey there, I just got approved for a construction loan and I was hoping to make a variation to the building contract to add extra bench and cupboards to my kitchen. Do I need the bank to approve it even if I’m just paying it out of pocket?

  • Hi Benn,
    You may not need approval from the lender if you’re paying out of pocket for minor improvements but you would need to provide the variation to the lender. It’s best to notify the bank of your intention to do so as early as possible.

  • Kelsea

    Hi there, can finance be sorted out prior to completing the build? The expected completion date is still 8-12 months away.

  • Hi Kelsea,
    Yes, it can be. You would want to apply for the mortgage about 2 to 3 months prior to completion because lenders usually do not take properties as securities whose completion date is over six months out. 8-12 months is a really long time and no lender will approve the mortgage at this stage.

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  • Matt

    Hi, We have a house with a mortgage of $345,000 which is currently valued at $480,000. We have plans drawn up for a renovation that a builder has quoted at $360,000 to complete. We have had a bank perform an ‘as completed’ valuation on it, which came back at $700,000. We have no plans to sell and are not renovating as an investment, so don’t have any problems over capitalising, but the bank won’t lend this amount based on their valuation. Is there a way that we can make this work?

  • Vishal

    Hi, we’re looking for a construction loan of $500,000 for an owner-occupied house. The land that we want to build on is owned outright and valued at $365,000. How much deposit will we need? Can we use the equity from the land as the deposit instead?

  • Hi Vishal,
    Yes, you can use the equity from the land for a construction loan. For a land equity construction loan, the banks will use the valuation figure of the land value plus the cost of construction as the total purchase value. So in your case, $365,000+$500,000= $865,000 which will be the total purchase value so, you’ll be borrowing at 57.80% LVR.

  • Rae

    Hi, quick question. When do they calculate the LMI on a construction loan? Is it at the start or end of construction?

  • Hi Rae,
    The LMI (lenders mortgage insurance) is calculated at the time of the initial assessment. LMI is generally only applicable if the loan amount exceeds 80% LVR (loan to value ratio).

  • Andy

    Hi, just wanted to know if the 20% deposit we are planning to put down has to be paid to bank or the developer?

  • Hi Andy,
    The deposit is payable to the vendor or the builder.

  • Patty

    Hi, we are building an investment property at the moment and wondering if we could refinance before the building complete (now it is at a final stage) ?

  • Hi Patty,
    Yes, it is possible to refinance before the building is complete, however, most lenders do not prefer it. The lenders will limit your loan to value to 70% and you may not get the most competitive interest rates.