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 step-by-step building guide for more information.
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.
NSW stamp duty changes
The New South Wales (NSW) government has decided to make temporary changes to stamp duty exemption for first home buyers.
From 1 August 2020, the NSW government increased the threshold for stamp duty exemption for first home buyers from $650,000 to $800,000 for newly built homes and from $350,000 to $400,000 for vacant land.
Read our page on NSW stamp duty changes for more information.
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.
If you’re building an investment property, some will even consider , future rental income which can greatly improve your borrowing power.
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.
Ensure each stage is complete before completing drawdown request
At each stage of the build, it’s recommended that you have a walkthrough to ensure that the property is being built to specifications and to quality.
You may want to consider hiring a building consultant so you can be sure that no corners have been cut.
This is particularly at the practical completion stage or last drawdown: don’t sign off on the last drawdown until you’re satisfied.
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?
This can add a 6-week delay to your construction and you may also be charged a premium by the builder!
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 fill in our 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
- Power pole / power connection
- 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.
The combination of a guarantor home loan 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.