Construction Loans Explained: How Do They Work?

Construction Loans Explained How Do They Work Intellichoice Finance

Construction Loans Explained: How Do They Work?

Are you looking for other avenues to acquire your dream home? Is your family getting bigger and you feel you are outgrowing your home? With home prices going down this year, you can actually find affordable home loans.

Australian Bureau of Statistics recently reported that from June 2017 and June 2018, values on home properties went down at -0.8%. This could be a good time for home buyers to invest in a home property as the downward motion of the charts can indicate a possible decrease in home pricing.

But if you are looking into rebuilding your home or constructing a house in a land property that you already own, there are specific financing options for you, the construction loans.

What are Construction Loans?

A construction loan is a specialized financing option for builders (including owner builders) and renovators. The financing option will be exclusively used to finish the building or renovation project. It has a different loan structure compared to regular housing loans.

There is a common misconception between Owner Builder Loans and a Construction Loan. Unlike construction loans, non-conforming lenders find it a little riskier to approve loans for owner builders compared to construction loans. An owner-build is a construction project wherein the owner is the actual contractor of the project as well.

The possibility of the owner-builder not being able to handle such projects makes banks and lenders a little bit hesitant in granting a loan for an owner build. Construction loans are backed up with registered contractors that has mot experience, funding, and expertise in such lines of activities.

How Do Construction Loans Work?

Construction loans are paid out in periodic progress payments throughout the various stages of the construction process. This is in contrast to regular home loans where payments are provided in a lump sum.

Upon approval of a construction loan, the construction process can commence. Lenders are going to make progressive payments generally in five stages as follows:

1. The Slab Down

This stage is also called the Base. The amount released on this stage is to help lay down the foundation or the base of the property. It includes the leveling of the ground surface, plumbing, as well as waterproofing of your the entire base or foundation.

2. The Frame Stage

The amount released on this stage helps build the frame of the home. This includes part of the brickwork, roofing, windows, and trusses.

3. The Lockup Stage

In this stage, the funds released will help put up the external walls and installation of windows and doors.

4. The Fitout or Fixing Stage

The amount released on this stage will help finish the internal fittings and other fixtures of the home building project. This includes part-installation of benches and cupboards, plumbing works, electrical works, and gutters.

5. The Completion Stage

The amount released on the final stage covers all contracted items such as builders and equipment used. The final payment also covers finishing touches needed for the home in order to be considered as completed.

A valuer checks on the completion of work on each stage before releasing funds from the lender. Each payment released is referred to as a drawdown. Interest is calculated based on the total drawdown.

For instance. If you were approved for a $500,000 loan and you received a drawdown of $200,000 on the third stage. The interest will be calculated based on the $200,000 total drawdown.

During the construction process, loan repayments are interest payments only. Upon completion of the loan, depending on the lender, you will assume principal and interest payments.

Application for Construction Loan

When applying for a construction loan, there are two things that lenders look at. Are you an owner builder who assumes the supervision and management of the construction process? Or Are you going to hire a licensed builder or contractor? These two things differ in the application process.

Note that when you are going to assume supervision and management during the construction process, lenders will require more documents from you. This includes, but not limited to, certified approved plans, permits and licenses down to insurance policies.

If you are interested in applying for a home construction loan, you can get in touch with a professional mortgage broker. They can help match you with the right lender to fit your needs.

If you are interested in applying for a construction loan or an owner-builder loan, head to this page for more information.