Getting a construction loan for your dream home

Whether you’re looking for a way onto the property ladder or downsizing for retirement, you probably have a wish-list and a certain image in your mind when you think of the perfect home. But finding a property to match isn’t easy. Every home you view will have upsides and downsides, and balancing must-haves and bonus features can be difficult.

Although buying an existing property is by far the most common way to purchase a home, there are other options. Buying a section and building from scratch might be more complicated and take longer than a traditional purchase, but it’s the best way to make sure you get your dream home, just as you pictured it.

But building a home isn’t cheap. Most people will need a loan to pay for the land and construction work involved. Because building takes time and costs can be variable, this type of loan is a bit more complicated than a standard mortgage.

Here’s what you need to know.

Getting started

Building a brand-new home isn’t for everyone. If you’re thinking of taking on a build, you’ll need to meet the criteria set by your lender. Construction loans are not usually bound by the same Reserve Bank rules that govern standard home loans, so deposit requirements can be lower. Of course, every lender has slightly different rules, but many require a deposit of 10% of the projected value of the home – although some will accept 5% in special circumstances.

Most lenders want a fixed price or ‘turn-key’ contract because it prevents costs from blowing out during the build.

If you’ve already bought a piece of land, you’ll need to provide proof of ownership and building plans. If not, you may be able to secure a loan with an extended period of approval, so you have time to hunt for a section and then plan the build. Some lenders will structure construction loans in two parts, one for the land and the other for the build. That way, you’re only paying the mortgage on the land until construction gets underway.

Making plans

Finding a builder and setting the terms of your contract is the next key step. Good builders will be able to help you plan your dream home with the help of a designer or architect if necessary. They should also be able to set a contract that works for them, for you, and for the bank. Once this is agreed, you can approach your bank with your plans, your building contract, and a projected valuation from a registered valuer.

Usually, your loan application is managed as two separate parts – one loan for the purchase of the land, and another for the value of the house when it’s finished. When the house is built and the second loan is completed, it will absorb the first loan and you’ll be left with a single standard mortgage.

The building process

Unlike a traditional mortgage, a construction loan isn’t paid out in a lump sum. Once your build gets started, the loan will be paid directly to the building company in stages set out in the contract. At each stage, the building work will usually need to be inspected and certified by a third party, to make sure it’s up to standard. In some cases, a registered valuer will need to come in and value the property during construction.

During your build, you’ll generally pay interest-only on the portion of the loan already paid to the builders.

Types of construction contract

Lenders will usually require a fixed-price agreement with the builder, but this can be done in a few different ways – each with benefits and drawbacks.

Land and build construction contracts are the most common type. These agreements set a specific fixed price for the entire project, along with details of the completed home. Only minimal price changes or overruns are allowed, which means the cost of building can’t get out of hand. During the build, the lender makes progress payments as work is completed at specific stages. As the borrower, you start paying interest on the loan after the first payment to the builder, and your payments increase as the work progresses.

Turn-key contracts set an agreed price for the full build, including landscaping and interior details such as painting and carpeting. They’re a good option for the borrower, because you’re not required to make any repayments on the loan, or even pay interest, until the build is finished and settlement is complete. However, it can be difficult to find builders willing to take on this type of contract, as they don’t get paid until the project is finished, and they often have to cover the cost of overruns.

Partial contracts also called labour-only contracts, can include several sub-agreements with contractors, managed by you or a project manager. These can be far more complicated than other forms of construction contract, so they’re best left to experienced home builders or renovators.

Costs and complications Home builds are rewarding, but they can also be complicated and expensive. Projects often take much longer than people expect when they start, as consent applications may take months to be approved, building work may have unexpected setbacks or delays, and contractors may fail to do the work as specified.

Builds can also be expensive beyond the obvious costs of the project. When you’re building a home, you usually need to live elsewhere for the duration of the project, which means paying rent on another property. Any delays in building mean more time spent paying these costs, as well as the cost of the construction loan.

Your home, your way

Although building can be time-consuming and frustrating, in the end, you get the home of your dreams, just as you imagined it. It’s up to you to decide whether that’s worth a few years of added costs, added work, and added stress.

Want to know whether you qualify for a construction loan? Talk to the expert advisers at Global Finance now.