Construction loan process explanation

How a construction loan works

To make it easier to understand the process, please see the example below

We will use a figure that assumes that there is already a loan on the land and add the home construction costs.

Assuming the land already has a loan amount on it of $300,000

Assuming the total construction costs will be $400,000.

Total bank loan required, once construction work is completed, is $700,000

In this example our client is starting with a debt of $300,000 on the land. They will only make payments on the $300,000 land loan until construction starts. 

Once construction commences, and as each stage of construction is completed, the lender will release each of the progress payments to the builder. Each client  receives an invoice from the builder, and will submit this to the lender, along with a progress payment request form, which is provided from the lender or mortgage broker.

These progress payments are added to your loan balance at the time of each payment. Loan payments will therefore increase with each progress payment added.

An example of the process using very basic figures:

• The slab for the home has been completed – invoice one is issued for $80,000. Our client’s loan balance is now $380,000.
• Frames and trusses are erected – invoice two is issued for a further $80,000. Our client’s loan balance is now $460,000.
• Brickwork and tiles completed – invoice three is issued for a further $80,000. Our client’s loan balance is now $540,000.
• Internal works are completed the lock-up stage – invoice four is issued for a further $80,000. Our client’s loan balance is now $620,000.
• Completion of the home is finalised – invoice five is issued for a further $80,000. Our client’s loan balance is now $700,000.

NOTE: Once the construction work has been completed, we generally need to re-apply with the same lender for a better loan rate. The loan cannot remain on an interest only facility and the construction rates are usually higher than the normal rates offered. 

Most clients who are applying for a construction loan are paying rent while they build. Usually, they have applied for an interest only loan, to make life a little bit easier while paying rent and the increasing mortgage payments at the same time. This obviously needs to be changed to a better loan structure as soon as possible after construction is finalised.

What benefits are there for you in a Construction Loan?

The pros:

• The obvious benefit to a construction loan is that you can design a homebased on your individual tastes and needs.
• Renovations on an existing property. Allows you to modify a home to be more suited to family life or create more space etc.
• The bank is in control of the payments, meaning that the builder must have the work approved before receiving payment. This offers some comfort in the knowledge that an authorised inspector will be looking at the property construction during any progress payment periods.
• Because the builder understands the lenders process and progress payment structure, they will always accept the terms regarding the progress payment process that the lender imposes. Most lenders will demand the first payment be no more than 20% of the construction cost. This stops the builder from loading up the first progress payment to have more of your money up front. The lender is ensuring that you are only paying for the stage of work that has been completed and is therefore protecting your interests. 
• If you have applied for a construction loan to fund renovations, then you will be able to commence building once it is approved. This is a much better option than saving up the cash over the next 10 years to pay for the construction, if that was an option. This allows you to finish your home and live in it sooner and be able to enjoy your home in its completed form, while you are paying your loan down.
• Interest only payments are available for most construction loans. This is an important feature. Most of our clients will be paying rent while they are going through the process of building their home. 

To ease the financial stress of repaying a home loan and paying rent at the same time, this is one essential feature that we can build into the new loan to keep the cost down until construction is completed.

What do you need to be careful of in a Residential Construction Loan?

The cons:

The loan must be set up with as many safeguards as possible, to reduce the chances of you not being able to make the loan repayments as the construction is progressing. Your mortgage broker will have a checklist of benefits, features and options that they would like to see implemented with your loan when they assess who will be the most suitable lender for your construction lending needs.

• Insufficient funds can lead to complications during your home build. To ensure a smooth process, it's crucial to factor all costs into your loan application to avoid any shortfall.

• Remember, building a home often involves more hidden fees and charges than buying an existing property. These costs can include land inspections and preparation, architectural and engineering fees, council approval, and finishing touches like fences, driveways, and landscaping.

• Thoroughly reviewing your building contract and accounting for as many of these potential costs as possible before applying for finance will help prevent unexpected financial strain.

• if you need to increase your loan amount due to underestimating the associated costs, you will likely incur additional fees and need to submit a new loan application.

To avoid the issues above, it's crucial to apply for the correct construction loan from the outset taking everything above into account. Your broker at Illawarra Mortgage Brokers can guide you through the available options and help you make the best choice for your needs.

Illawarra Mortgage brokers will be exploring the different construction loans available to you based on your specific circumstances. 

They will also explore options for converting the loan with the same lender once construction is complete. It's crucial to understand how competitive the converted loan will be before committing to any lender, to avoid unnecessary refinance fees.

Remember that your residential construction loan will typically last for a short period, such as one year, while your ongoing loan will extend for 25 years or more. Therefore, it's essential to prioritize the terms of the ongoing loan over the construction loan.

In summary, we need to ensure that the lender offers suitable loan options for both the construction phase and the period after construction.

Contact a Mortgage Broker on (02) 4257 5626 to discuss your options or fill out our online enquiry form. You can find out what your options are in a matter of moments.

How can I apply?

These are your simple steps to apply for a loan.

• Contact us on the numbers above to speak to a mortgage broker, or complete our online enquiry form.
• You will speak with a broker who will take into account your needs by discussing not only your requirements, but also any concerns you have, and offer you some possible strategies and ideas that you may not have thought about.
• Once we know what you require, we will draft and email you a proposal– this will usually consist of a few options that are easy to understand.
• Once you have had a chance to look at what options are available, you can contact your broker or the broker will call you, to discuss the proposal.
• You can then decide if you wish to proceed or you may just want to discuss more options.

Other loan options

We offer a wide range of loan products to suit various needs, including refinancing for lower rates and investment property purchases. Whether you're a first home buyer, looking to refinance, renovate, build a home, or if you are expanding your property portfolio, we can help you find the right solution.

• Please contact us at 02 4257 5626 or request a call at a time that suits you. We'll be happy to discuss your individual circumstances and guide you through the available options.