Construction Loan Rates From 5.18%

Construction home loan interest rates

You may have noticed construction loans typically have higher interest rates than standard home loans. This is because it's difficult for a lender to value a home that doesn't exist yet. To compensate for the risk, lenders tend to charge higher interest rates for construction loans.

In addition to higher rates, construction loans can also come with higher fees. A notable one is the valuation fee, which tends to be more costly with construction loans as the lender generally requires a valuation after each stage of the building process. Given the added layers of complexity, construction loans can also command higher administration and upfront fees.

What is a construction loan?

As the name implies, construction loans are a specific type of home loan designed to assist funding the construction of new homes. They can also be used to finance renovation projects on an existing home.

Standard home loans don't fit the bill as they only apply to existing properties. With standard loans, if you default on your loan repayments, your lender can repossess and sell the property in a bid to recoup its losses. It's not as easy as that with a partly built home.

That's why getting a loan for a home that isn't built yet is a bit trickier. It's also why construction loans work in alignment with the building process, with funds released in stages as the home progresses.

How does a construction loan work?

Construction loans are specifically tailored for those seeking to build their own home or renovate an existing dwelling. These loans differ from standard mortgages as instead of receiving the full loan amount all at once, the lender will make progress payments directly to the builder.

With a construction loan, borrowers will typically make interest-only repayments while the building work is being carried out before the loan reverts to principal and interest (P&I) repayments once the home is completed and ready to live in.

Construction loan payment process

With construction loan funds released in stages, the lender will assess each stage before money is released for the next stage to proceed. This release of funds on your behalf is known as a 'draw-down' on your overall loan.

Typically, building a house has a number of construction stages including:

• Preparation - includes plans, permits, connection fees, insurance.

• Base - includes concrete slab, footings, pad, and base brickwork.

• Frame - the house frame is complete and approved.

• Lock-up - the windows and doors, roofing, exterior and insulation are all done.

• Fixing - kitchen cupboards, appliances, bathroom and toilet are all in. Plumbing and electrics are done. Your home is plastered and painted.

• Completion - fences up. Site tidied. Any builders or tradespeople receive their final payment.

Obtaining a construction loan

Gaining approval for a construction loan is generally more difficult than for a standard home loan and frequently involves considerable paperwork. This is because, in addition to assessing your suitability as a borrower, the lender also has to look at the risks involved with the dwelling you're proposing to build.

Lenders will typically ask to see:

• Specific written details such as council plans and permits for the construction

• Your fixed-price contract (if you are working with a builder)

• A quantity surveyor report

• Your progressive payment schedule (if you plan to do the work yourself)

• Evidence of builders' insurance and other insurance provisions

• Contingencies if plans fail or run behind schedule

This is on top of the usual paperwork that comes with home loans, including:

• proof of identification

• income details

• existing assets and liabilities

• monthly bills

• other financial commitments

This is why it can take some time for construction loans to be approved. There are a lot more players involved including councils, quantity surveyors, your builder, you, and your lender. You'll need to ensure the required documentation is completed and provided - and be patient.

What if you want to complete your own construction?

If you are looking to do the construction yourself, you also will need to obtain an owner builder permit.

The requirements to obtain an owner builder permit differ slightly between the Australian states and territories. Many jurisdictions in Australia require applicants to complete an accredited owner builder course.

These are designed to equip you with the necessary knowledge and skills to responsibly undertake a building project covering construction regulations, project management, and managing contractors.

If you carry out owner-builder work without a permit, you can face considerable fines, so you need to read up on the regulations that apply in your state or territory before you hammer the first nail.

See also: How to obtain an owner builder construction loan

Construction loan pros and cons

As with most lending products, construction loans come with their advantages and disadvantages. It's wise to weigh them up before signing on any dotted lines.

Pros

• Construction loans ensure that builders and contractors are only being paid for completed work, not for work that is yet to be finished. This can give you access to funds when they're needed and also cut your losses in the event of any issues that disrupt or halt the building process.

• As you are only charged interest on the loan amount used per stage and not the loan principal, this can ease cost burdens while the home is being built. It can also lead to significant savings over the loan term compared to standard lump sum home loans.

• Stamp duty is an unavoidable cost that many home buyers have to pay but if you build a home, stamp duty is only paid on the purchase of the land and not calculated on the value of the home itself. This can make building a home significantly less expensive than buying an existing house. For example, if you buy a block of land for $350,000 and spent another $500,000 building the house, you'd 'only' pay stamp duty on the $350,000 for the initial land purchase.

• You get to watch your dream home unfold, before your very eyes.

Cons

• The amount of paperwork and hurdles you may face can leave you wanting to pull your hair out. Approval for a construction loan requires a significant amount of work beforehand, and (if you're not building the home yourself) many long conversations with your builder.

• The deposit needed for construction loans can be significantly higher than for a standard mortgage.

• The interest rates on construction loans are generally higher than those of regular home loans as the lender assumes more risk.

• Not only can it be time-consuming to begin construction thanks to the mountain of paperwork you have to provide, but the progressive draw-down payment style of construction loans can slow down the building process since moving from one stage to the next typically requires lender approval.

• Many construction projects face unexpected cost overruns that no amount of planning can foresee. It's vital to have contingency plans for extra funding in place as your lender may not agree to increase the loan amount.