Construction loans are designed to assist people who need finance to get a house built. They’re structured slightly differently from conventional home loans to allow for the extended time it takes to build a home. Read on to learn all about construction loans, how they work and why they might be right for you with Savvy.
What are construction loans and how do they work?
Construction loans are home loans designed specifically for people wanting to build their own home. The main difference between them and a conventional home loan is that construction loans in Australia are paid in stages directly to the builder, rather than being paid to the borrower.
Typically, a 5% deposit is paid to the builder and approximately another 20% of the purchase price as each stage is reached. These payments are known as progress payments. Construction loan rates are usually slightly higher than variable rate loans and can either be variable or fixed interest-only loans.
Quite often, the loan only extends until construction is complete and either the loan is paid off, refinanced or reverts to a standard principal and interest home loan with a variable interest rate.
What finance options do I have when buying land and building a house?
The finance options you have depend on whether you already own land and wish to build on it, if you want to buy a parcel of land and build later or choose to go with a house and land package.
- If you already own land: you’ll just need a loan to cover the construction cost of your home. Choose from a variable or fixed interest rate construction loan, either paying interest-only or principal and interest. Loans on which you pay the principal and interest from the beginning of the agreement work out to be cheaper than those with interest-only periods. Low doc construction loans are also available for self-employed applicants who aren’t able to supply two years’ worth of tax returns.
- If you wish to buy land and build later: construction loans usually have a time limit (between six and 18 months), so if you wish to buy land and wait to build, a construction loan may not be the best option for you at the beginning of your journey. You may need to first get an investment or loan to buy your vacant land and either get a second construction loan when you’re ready to build or refinance your investment loan to a construction loan down the track. Compare your options with Savvy and talk to your lender about the best option available for your personal circumstances.
- If you’re after a house and land package: some property developers team up with builders to offer house and land packages, where one loan covers both the purchase of your land and the construction of your house. These construction home loan packages offer the convenience of just dealing with one lender for all your finance needs, but they may not always offer the best construction loan rates in Australia. Make sure you compare home loan packages before committing to the one recommended by your builder, as construction loan rates do vary widely and there’s plenty of competition to ensure there are always affordable offers on the market.
How much will I need for a deposit on my construction loan?
Lending criteria do vary between different financiers, but most will require a deposit of between 5% and 10% of the amount you wish to borrow, although others may require up to 20%. Lenders will calculate your loan-to-value ratio (LVR) as part of assessing your construction loan application. Your LVR is calculated by dividing the estimated value of your home once it’s built by the deposit you can provide and multiplying this figure by 100.
If your LVR is higher than 90% (or 80% with some lenders), you’ll usually be required to pay for Lenders Mortgage Insurance (LMI). This is an insurance premium which protects lenders from the possibility of mortgage default. It is an additional cost which borrowers have to pay to protect their lender and can amount to thousands of dollars.
What documentation will I need for my construction loan?
Construction finance requires you to provide additional documents compared to the standard ones needed for a traditional home loan. Standard documents you’ll need to supply for a home loan include:
- Suitable identification to prove your ID: for example, your driver’s licence, passport and Medicare card
- Proof of income: for example, payslips, tax returns or Business Activity Statements if you’re self-employed
- Evidence of any assets you own: this includes all vehicles you may own including trailers, caravans or other recreational vehicles. Also include any bank account savings you may have, plus any other investments or items of value, including your superannuation
- Details of any debts you have: this includes any personal or car loans, all credit cards and any store lines of credit you may have (including ‘buy now, pay later’ agreements)
- A budget showing all your monthly income and bills and expenses: you can create your budget with Savvy’s budget planner calculator. This is important to show you can meet your loan repayments once all your other living expenses have been paid
Additional documents you’ll usually need to supply for construction loans include:
- Your building contract
- Your building plans
- Council approval to build your home
- Your builder’s current licensing/registration certificates
- Insurance details (both your builders’ and your own)
