Building a new home is an exciting prospect, but the lending side works quite differently from buying an existing property. Construction loans have their own structure, requirements, and process. This guide explains what you need to know before taking on a construction project.
How Construction Loans Differ from Standard Home Loans
With a standard home loan, the full amount is advanced on settlement day. With a construction loan, funds are drawn down progressively as building milestones are reached. This means:
- You typically only pay interest on the amount drawn down so far
- Funds are released in stages, not as a lump sum
- The lender may require valuations or inspections at each stage
- The loan converts to a standard home loan once building is complete
Types of Construction Lending
Progress payment loans
The most common structure. Funds are released at agreed milestones, usually:
- Deposit or land settlement: Typically 5-10% of the build cost
- Foundation stage: Once foundations are laid
- Framing stage: When the frame is erected
- Lock-up stage: Roof on, windows and doors in place
- Fit-out stage: Internal linings, plumbing, and electrical
- Completion: Final payment when a Code Compliance Certificate is issued
Turn-key contracts
With a turn-key build, the builder funds the construction and you pay the full amount on completion. This simplifies the lending process as it operates more like a standard home purchase, though you may need a longer finance period.
Land and build packages
If you are purchasing land and building on it, the loan can be structured in two parts: the land settlement is funded first, then the construction loan kicks in for the build.
Deposit Requirements
Most lenders require a minimum 20% deposit for construction lending, calculated on the combined cost of land and build. If you already own the land, the equity in that land can count towards your deposit.
Some lenders may consider lower deposits depending on your overall financial position, but this is assessed on a case-by-case basis.
What Lenders Want to See
To approve a construction loan, lenders typically require:
- A fixed-price building contract with a licensed builder
- Council-approved plans and building consent
- A detailed specification of the build
- Proof of insurance: Contract works insurance and public liability
- A registered valuation of the completed property (as-if-complete valuation)
- Your standard financial documents: Income, expenses, ID, and deposit evidence
Managing the Build Process
During construction, there are several parties involved in the draw-down process:
- Your builder invoices at each milestone
- A valuer or quantity surveyor confirms the work has been completed
- Your solicitor may certify draw-down requests
- The lender releases the funds once satisfied
A mortgage adviser experienced in construction lending can coordinate this process for you, ensuring payments are released promptly so your build stays on schedule.
Common Challenges and How to Avoid Them
Budget overruns
Always include a contingency buffer of 10-15% above your contracted build cost. Unexpected costs can arise from ground conditions, design changes, or material price increases.
Delays
Weather, consent processing, and supply chain issues can all cause delays. Make sure your finance pre-approval has enough runway to cover a build that runs longer than expected.
Builder disputes
Work with a reputable, licensed building company and ensure you have a clear, detailed contract. Your solicitor should review the building contract before you sign.
Interest costs during the build
Remember that you will be paying interest on the drawn-down portion of your loan during construction. If you are also paying rent or an existing mortgage, factor this into your budget.
Converting to a Standard Home Loan
Once your build is complete and a Code Compliance Certificate is issued, your construction loan converts to a standard home loan. At this point, you can fix your interest rate and set up your regular repayment structure.
This is also a good time to review the market, as a better rate may be available than what was offered when you first arranged the construction loan.
Expert Construction Loan Advice
Construction lending is a specialised area, and having the right adviser makes a significant difference to how smoothly your project runs. At Sunshine Mortgages, our team has extensive experience with construction finance and will guide you from pre-approval through to completion.
Book a free consultation to discuss your build project.