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Construction Loan Tips

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 that some experts won’t understand each other’s field and things may go wrong.

It can also be exceedingly complicated to obtain finance. The majority of mortgage brokers and bank employees don’t understand construction at all!

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. We have created this guide to help you ensure that you don’t have these same frustrations with your construction mortgage.

Your expectations are the key

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. This can lead 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!

How does the construction process 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 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 & 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.

You can 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.

We’ll 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 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 & construction as 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 & 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 and 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’re borrowing a high percentage of the property value, may have enough funds to complete the project, but may not have enough funds to settle on the purchase of the land.

Each state & territory has their own incentives for both first home buyers and those building homes. We recommend that you contact your state government to confirm the incentives that you may be eligible for.

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 guarantor home loan with a construction loan is a particularly difficult situation. 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!

Do I need a building certificate?

Find out whether or not you need a building certificate by checking out our Do I Need A Development Application (DA)? page.

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 upon the plans for any property purchased for the purpose of building, renovation, knock 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.

  • Sarah

    I am having my home constructed by a professional builder, and have my base laid out and slab stage completed. However, the expenses had been more than what was provided to us by the builder before. So, how can we claim the extra money, will the bank lend us the additional funds required?

  • Hi Sarah,

    This is a very tough situation to be in, in terms of the lenders perspective. There are various possibilities, depending on the situation.
    1. Discuss with your current lender if they can accept the additional costs to be added onto the loan amount, i.e. if you had initially borrowed less than the maximum the lender accepts.
    2. If this does not work, you could possibly refinance your incomplete property and go to a lender that accepts this as security and lends you the required amount. The total lending however should still remain under 80% of the property value.

  • Emmy Burrell

    Is the construction loan normally 80-95% of the land value or contract value?

  • Hi Emmy,

    With a construction loan you can borrow up to 95% of the land value and also up to 95% of the contract to build the house.

    E.g. land is $500,000 and house costs $500,000 then you can borrow 95% of $1m ($950,000).

    In some cases the bank valuer will assess the end value to be less or more than the cost of construction. In these cases the bank would lend 95% of the lesser of the cost or value.

    E.g. with the above example if the bank valuer’s assessment of the end value was $900,000 then they would lend 95% of $900,000 and if the end value was $1.1m they would lend 95% of $1m.

  • Emmy Burrell

    Is that with all banks?
    I’m with Westpac.

    What’s the minimum %? Is it 80%?

  • Hi Emmy,

    The banks vary with construction loans. Some decline all constructions loans, some lend 80%, some 90% , some 95%. With a guarantor loan you can borrow 105%.

    With Westpac there is no minimum, you can just borrow as much as you need. It’s recommended to have a buffer in most cases as the cost of construction often goes over the expected amount.

    FYI we can do loans with Westpac and also get you quotes from other lenders as well. Feel free to call our brokers on 1300 889 743 if you’d like to compare your options. In most cases our services are free and we get often put in a pricing request to get better rates than you can get directly.

    Best of luck with your project.

  • bec

    my husband and I want to renovate – add bedrooms, deck etc to our existing home. It is valued at approx $400k and we only have a $40k mortgage. The renovation/construction is under $150k but we would like to refurnish as well. Is there any other loan available instead of a construction loan? we already have the equity

  • Hi Bec,
    We have a few specialist equity loans that can give you the money so that you can spend it as you want rather than having the bank control the funds and pay your builder in draw downs. That means if you want you can pay contractors directly rather than having a builder and as a result it’s usually a fair bit cheaper. This only works if you have a lot of equity, thankfully you’re in a good position so this should be fine.

    Please call us on 1300 889 743 and ask for a broker who is a specialist in equity loans.

  • bec

    Excellent, thank you. I have already spoken with someone and they have sent me some information.

  • Great thanks Bec happy to help. Make sure the new deck has a spot for a BBQ ;)