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How a construction loan makes building easier

Can’t find your dream home anywhere? Why not build it? With a construction loan, buying a section and building a brand-new home could be simpler than you think.

Building a home can be complicated – you have to deal with the council, architect, builders and contractors, not to mention choosing a design and fittings – but the finance part could be simple. A construction loan is a mortgage designed for building from scratch, putting an extension on your property or constructing a minor dwelling. Features like long-term pre-approval, interest only repayments on construction loans during construction, and payment in stages help things run smoothly and minimise your costs at a very expensive time.

Construction loan vs traditional mortgage

In a traditional mortgage, your bank lends you a lump sum of money to buy an existing property. If things go wrong and you can’t repay the loan, the bank has the property as security.

Building a house is a bit different. Essentially, you need two loans – one to purchase the land, and a second to finance the house build. You can buy the section first and apply for a second loan to build, or choose a construction loan and have both elements folded into the same mortgage.

If you opt for a construction loan, your money is paid out in separate portions, first for the cost of the section, and then the cost of building is paid as it is completed. Usually, your loan won’t be entirely paid out until the building has approval from the council.

Because construction loans are riskier for the lender, they usually have higher interest rates compared to standard mortgages. Once your house is built and the loan is complete, your lender will switch you over to a standard mortgage with a lower rate.

Pre-approval while you search

As we all know, location is the most important factor when it comes to house-hunting, and section-hunting is no different. Finding the perfect spot for your dream home can take a while.

That’s why most construction loans offer long-term conditional pre-approval while you search. Your lender will assess your financial situation, including your deposit and income, and offer you a set loan amount. Most lenders require a deposit of at least 20% for this type of loan.

With this information in hand, you can hunt for a section, get a rough estimate of costs for building, and know exactly how much you can afford to pay for each.

Staggered payments and flexibility

By paying out only as needed, a construction loan helps keep your costs down. When you buy your section, your loan covers that cost. When you start building, the lender will usually make payments directly to your building company, based on specific elements being completed. Often, the lender will require repeated inspections to make sure each part is finished. As you go, you’ll only be making payments and paying interest on the portion of the loan that’s been paid out.

Flexibility is another benefit. Construction often includes unexpected costs and budget blowouts, which makes things complicated if you have a very strict loan limit. Many construction loans account for this by including ‘soft costs’, or room for unplanned extras that come up during the build. That way, if your section turns out to be unexpectedly rocky, the cost of excavation work will be covered. If there is any additional lending required in such situations these applications are approved at a banks discretion.

Payment breaks while you build

Building a house can take a year or more. Not only are you paying for the build and the mortgage on the land, but unless you can live onsite, you’re also paying rent or a mortgage on another property. This can make things very expensive, particularly if your build takes longer than planned.

Many lenders offer interest-only payments or repayment holidays during the construction stage. Although this doesn’t reduce the cost of the loan overall, it does help keep day-to-day costs down until you can move into your new home.

One less worry when you build

Building from scratch isn’t for everyone – but it can be a great way to make your dream home a reality. Because they offer flexibility and help keep costs down while you’re building, construction loans are the best option for home builders. You still have to deal with the builders, the architects, the council, and everything else that goes along with building a home, but the finance is taken care of.

Want to find out more about finance for your dream home? Talk to the experts at Global Finance.

**These are general guidelines and are by no means a reflection of bank or lending policies