What are construction loans and how do they work? A construction loan is designed to allow you to borrow the money for your yet to be built new home. Even though your new home is under construction it can still be used as the security for the mortgage.
The funds for the construction are paid to the builder progressively in a series of drawdowns. These drawdowns are paid as each stage of construction is finished and a successful inspection is completed. This helps minimise the interest you pay as the amount owed grows over the construction period.
Also, construction loans are generally interest only during the construction period, which minimises the borrower’s repayments. This is especially useful to those borrowers who are renting during the construction period.
The lender will require the following additional documentation from the borrower when using a construction loan.
- A copy of council approved building plans.
- A fixed price building contract with a licensed builder. Ensure that this is the final contract, keep in mind that any change to this contracts price can trigger the lender to reassess the construction loan.
- Builders Risk Insurance, a current copy of your builders “Public Liability Insurance”
The drawdowns are paid to the builder in a series of stages. The HIA (Housing Industry of Association) and the MBA (Master Builders Australia) have clearly defined progress payment plans which are commonly followed when drawing down your construction loan. Generally, there are five stages of construction when building a new home:
- Foundation: The Levelling of the site, the laying of the slab and the installation of plumbing. Once successfully inspected 10% of the construction loan funds are drawn down.
- Framing: The building of the frame, the support structure for the entire building. This includes walls, roof trusses, gutters and insulation. After a successful inspection a further 15% of the construction loan is released.
- Lock up: Quite literally your new home is completed to the lockup stage, so external doors and windows are installed. This secures the house for the next stage of construction. Once again, an inspection is required and a further 35% of the construction loan is drawn down.
- Second fix: In this stage all the internal fittings are installed. All the plumbing and electrical works are finished, along with the plasterboard and tiles. The kitchen and bathrooms are mostly finished. After a successful inspection an additional 20% of the construction loan is drawn down.
- Completion: This is the last stage where all the painting and other details are completed. The site is cleaned, and your new home is ready for you to move in. The final inspection is conducted, and a certificate of occupancy is issued. At this stage the final payment of 15% is drawn down from the construction loan and the construction loan converts to a standard mortgage.
One of the services we often recommend to our clients who are using construction loans, is to secure the services of an experienced building inspector to conduct additional inspections at the various stages of construction.
These inspections are to ensure the builder and contractors are completing the construction of your new home to an acceptable standard, with a focus on detecting non-compliance to the various construction codes and substandard workmanship.
It is nice to have an experienced building inspector in your corner ensuring that the construction of your new home is being completed to an appropriate standard.