Construction loans are designed to cater to the specific needs of building and renovation projects. The loan covers costs such as materials, labour and other expenses involved with building. So how does a construction loan work?
Who qualifies for a construction loan
The first thing to be aware of is that this type of loan is only available for houses being built and retained for personal investment or residential purposes. It is not an option if you are planning to immediately sell the property upon completion of building.
Time Frame Requirements Construction of the property is generally required to begin within 6 months of the Disclosure date on your loan contract and completion of construction is required to occur within 24 months of this date.
Deposit
The deposit will depend on certain factors. For owner-builders, it can be up to a 50%. Without insurance, up to a 20% deposit may be required before construction can commence. These requirements will vary between lenders. The deposit can be obtained from your equity in the vacant land or the building being renovated. Alternatively it can come from a guarantor, from an assistance scheme or from your savings.
Additional Documentation
Along with the usual loan application documents required, such as proof of income, a construction loan will require additional documents be provided including Council-approved plans, a fixed price building contract and Builder’s Indemnity insurance (which is paid by the borrower).
Progress Payments
Unlike your typical home loan, a construction loan releases money to you in stages as your construction progresses. These progress payments help to monitor your project and `mean that you only pay for work that is completed.
Initial Interest-Only Repayments This type of loan is particularly beneficial for people building or renovating as you are not required to make repayments on the full loan amount during the period of construction. During this period you are only required to make interest-only payments. This means you will have more of your income available to you for expenses that arise during construction, such as renting during your building process. However, if you want to, you can make additional payments to your loan at any time.
5 Stages Throughout the process, each stage will involve actions such as initially sourcing a pre-approval and then drafting of unsigned build contract which include specifications. The lender will then have to order a valuation and provide you with builder commencement letters. As construction progresses your builder will provide you with invoices for progress payments and send you items, such as insurance details, required by the bank.
Typically a construction is considered to involve five basic stages. These are:
1.Slab: Pouring the foundations and usually also includes the deposit with the payment of this stage.
2.Frame: Erecting the exterior walls and the building frame. This includes insulation, support structures and conduits for plumbing and electricals.
3.Lock-up: Installation of remaining windows, doors and walls.
4.Fixing/Fit Out: Installation of internal fittings and fixtures.
5.Completion: Final progress payment is usually made when the construction is totally completed.
Invoices, Authorised Payments and Inspections
A builder will provide you with an invoice following completion of each stage, which you present to your lender. You then authorise the lender to make the progress payment, to the builder, from your construction loan. During the period of construction/major renovation, the lender may conduct a progress inspection of the property. These inspections will be arranged with the builder by the individual conducting the inspection.
Fees It should be noted that there are various fees charged to cover the administrative costs of this process, including fees for servicing the loan, verifying information, inspections, processing the application and a progressive draw fee each time the borrower authorises a payment be made.
Insurance Policy Prior to the final payment, the lender will require you to provide a copy of the insurance policy or Certificate of Currency for the building. You must ensure that the lender is listed as the mortgagor when obtaining insurance.
Progress to Principal & Interest Repayments Once the construction/major renovation is completed you can choose to continue making interest-only repayments for 3 or 5 years, or choose to begin making repayments on both the principal and the interest. The duration of the interest-only period is selected at the time that you apply for the loan.
Things to consider with a construction loan
There are few things to consider prior to embarking on a building/major renovation project. Unlike purchasing an established property, building is a much longer process which can require a lot of effort and engagement. It is also a process requiring a range of stages, so it is wise to consider all the stages involved and have a solid strategy for achieving your end goal. This includes factoring elements such as a realistic understanding of the spectrum of materials and costs involved so that you can effectively budget.
Construction can involve many problems, delays and additional costs if it is not effectively planned. So it is vital that you help ensure the process is conducted as smoothly as possible by carefully preparing information and the people involved. This includes sourcing a reliable builder, and obtaining an estimate of costs. It is advisable to do some research to determine how long they have been in business and how well they have performed in previous projects. Picking the wrong builder can lead to serious problems and a very stressful and costly experience. Try to include a contingency plan to help you be prepared in the event of potential building variations.
Benefits
Whilst building a home involves a greater amount of time, effort and attention to detail, it has some major benefits. You have extensive control in creating the home you will live in. You select an array of details: layout of rooms, external materials, flooring, interior design, position of power points and light fittings. This is an opportunity to create your vision of your perfect home to life.
Building can result in significant savings on stamp duty as you only pay it on the cost of the land, rather than on the usually higher purchase amount involved with the purchase of an established house.Moving into a home which is newly constructed also means you are entering a residence which is going to require less maintenance as it had not undergone the wear and tear of time and use.
Written by Natalie Estalote Astill
Mortgage Broker at Paramount Home Loans Illawarra, working in partnership with Illawarra Mortgage Brokers
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