14th August 2018

How does a construction loan work?

When the average renovation costs $66,900 in Australia, you can see why at times it makes more sense to rebuild or build a new home.

A lot of the time, however, you might not have the available funds to finance the build upfront, which is where construction loans come in as a viable way to pay for the build of your new freshly-built home.

What is a construction loan?

A construction loan is specialised finance to help you pay for the building and construction of your new house with staggered payments. Most lending institutions will pay your builders and contractors directly on your behalf.

With a construction loan, you can borrow a certain amount determined by the value of your property after all the construction work has been done and not as it stands before the work begins, which gives extra lending power.

The loan is paid in installments at different stages of construction from your lending institution. This is known as progress claims. Payments are often monitored by the financier and will only be paid upon successful completion of certain stages of the construction process. These stages often have to be sighted by a valuer to ensure they are done to a certain standard and as agreed upon in the loan contract.

At the end of the construction stages, the loan reverts to a principal and interest loan or an interest only loan – depending on your financier’s requirements.

The benefits are vast

Using a construction loan means the money is distributed over the construction process. Builders and contractors are paid upon completion of their required building stages rather than upfront, giving you extra peace of mind that the work will get done.

Additionally, the interest on your loan will only be during the construction period after you’ve taken each payment lot, freeing up your cash flow. This is different to other loans where you get the total lump sum upfront and have to pay interest from the start. With a construction loan, you only pay the interest on the progress payments you or your builder have received.

For example, it can take up to 6-8 months to build a house, and if your home is half way complete you will only be paying interest on the first 3 progress payments.

The stages of construction in South Australia

Generally, the stages in a construction loan and the matching milestones of your payments are:

  • Foundations
  • Frame
  • Roof and external walls
  • First fix
  • Second fix
  • Practical completion

*these stages can change from state to state

Foundation stage

This is the stage of construction where the slab of your house is laid and the concrete poured. It’s a pretty exciting stage of the process, as the base of your house is complete! It’s where the footings and foundations of building your house begin including levelling. Generally, ten per cent of the construction loan is arranged at this stage.

Frame stage

The next stage is where the frame structure of your house, including the wall frames and roof trusses, are erected after the foundation stage has been approved by the valuer.

Some of the other building work such as brickwork, roofing, initial plumbing and gas is often done at this stage.

Roof and external walls

This is an exciting phase of home building process as your dwelling starts to look like an actual house. You can expect the roof cover, external wall cladding, windows and doors to be added to your home. The subsequent finance will be released at this time.

First fix

All those interior essentials will be included in the first fix stage, including plasterboard, insulation and first fix electrical and plumbing. You might also see drylining of walls and ceilings completed at this stage.

Second fix

The second fix stage is one that takes a structure into something pleasing. Cupboards and cabinetry, benches, architraves, doors, bathroom fixtures and other installations that really make a house a functional home are all completed at this stage of the build. External features such as garages, pergolas and verandas are also undertaken at this stage.

Practical completion

The final stage – great! Before you can move in, you’ll need to go through a handover process to make sure you’re 100% happy with your new home. At this stage, all those enhancing details such as tiling, shower screens, external works and other fittings are completed so that your home is finalised and ready to move in and live in your dream home.

This is a crucial stage for your construction loan as your lending institution will likely require a bank valuation inspection at the time of practical completion.

Your payments will be given to you or your building contractor (depending on your agreement) at each of these six stages and will make building and finance a much more manageable process.

If you’re looking to build a new home and want to find out if a construction loan is for you, get in touch, we can help you understand the process further.

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