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Building your dream home? A guide to construction loans

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If you’re looking to build your dream home or renovate an existing home, chances are you’ll need some help paying for the construction. The good news is you may be able to secure a special type of home loan known as a construction loan to help you achieve your goals.

What is a construction loan?

A construction loan is a specialised loan that covers the cost of building a new home, renovating an existing home or knocking down and rebuilding a home.

How do construction loans work?

A construction loan is different to a standard home loan, where you generally receive your approved lump sum payment at settlement. With a construction loan, you’ll agree on a total loan amount with your lender upfront, but it will be released gradually at the various stages, as agreed to by your builder.
These construction loan payments – known as draw-downs or progress payments – are usually broken into five stages.

Stage one: Laying the foundation of your home, including levelling, plumbing and base brickwork.
Stage two: Framing your home, which may include roofing and brickwork.
Stage three: Lock-up stage, including the construction of doors, walls and windows.
Stage four: Installation of internal fittings and fixtures such as benchtops, cupboards, electricity, paint, etc.
Stage five: Finishing touches such as fencing, polishing and cleaning.

What are the pros and cons of construction loans?
Pros
Protection: Progress payments mean your builder will only receive payment once they’ve completed the work to the required standard. Lenders will often ask an expert, such as a valuer, to visit your property to verify the work.
Less interest: Unlike standard mortgages, with a construction loan you’ll only need to pay interest on the amount of the loan you’ve used at that point in time.
Lower repayments: Construction loans are generally interest-only for the period of the house build (usually one to two years). After this time, most borrowers convert to a standard home loan, which can be fixed or variable and include interest-only or principal and interest.
Cons
Lots of paperwork: As construction loans are generally riskier for lenders than standard loans, be prepared to provide lots of paperwork during the application process. Along with the standard documentation about your finances, income and identity, you may need to provide a building contract and council approved building plans. You’ll also need to provide additional information before the lender makes the first payment.
Larger deposit: Again, due to the risky nature of new builds, construction loans typically require a higher deposit or loan to value ratio (LVR) than standard mortgages. This is even higher if you’re managing the build yourself.
Higher interest rate: You may need to pay a higher than average interest rate during the construction phase, but this will revert to the standard rate once your home is finished.

Mel Finance’s top tip
It can be a good idea to organise a small line of credit to pay for any urgent bills for work not managed by your primary construction company. This will help you avoid a situation where your builder is asking for payment from your lender, but the lender is waiting for that stage to be fully complete before releasing the payment.

Need help securing a construction home loan?
Construction loans may be harder to get than standard loans, but Mel Finance are experts in securing construction loans for our clients. Contact us today for friendly and professional home loan advice tailored to meet your needs.

 

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