How Does Construction Financing Work – The Brisbane Homeowners Guide to Construction Financing 2021
The great Australian dream has always revolved around owning your own home. But for a growing number of Aussies, this dream involves not just buying but actually building their dream home. According to the HIA ‘Window into Housing 2020’ report, 173,285 new homes were constructed across the country in 2019, housing an estimated 448,635 people. With a range of government grants available during the past 12 months encouraging more people to build, you may be wondering exactly how does construction financing work. Is it complicated? What kind of documentation will you need? Does the builder invoice the lender directly? Are construction payments made up-front? And do all lenders currently offer construction loans? To help you get a better understanding of how do construction loans work, we’ve put together a Brisbane homeowners guide to construction financing in 2021.
What is Construction Financing?
So, what is construction financing? Simply put, it’s a tailored lending solution for borrowers who want to buy land and build a new home. It can also be used to buy and substantially renovate an existing house. The key difference between a standard home loan and a construction finance loan is found in the way the loan is structured.
With a typical mortgage, you borrow the total amount of the loan, in full, on the day of property settlement. From that date, you are then paying interest on the total balance of the loan. In contrast, most construction finance loans will be structured with progressive drawdowns. This means that the lender will release the money in instalments (which have been agreed on in advance) throughout the construction project. This ensures that you aren’t paying interest on the entire loan until your new home is completed.
Is Construction Financing More Complicated Than a Typical Home Loan?
Construction financing can be more complicated than buying an existing house with a typical home loan. Why? Because when you’re building a new house, there are a lot of different parties involved in the process. This includes:
- Builders (who are contracted to handle the bulk of the work)
- Contractors (who may care for specialised works such as electrical or plumbing connections)
- Building surveyors (who issue the permit and ensure the house is built to comply with current housing standards)
- Local council (who may be involved in planning approvals)
- Lenders (who are paying for the whole project)
- Other qualified experts (such as solicitors or accountants)
Each of these parties may have a significant role to play in the construction of a new home. But with so many stakeholders, it’s easy for complications to arise. To prevent issues from happening once the project is already underway, many lenders will require extra documentation before approving a construction finance loan.
Can I Get a Regular Home Loan Instead of Construction Financing?
On hearing that a construction finance loan is more complicated, many borrowers will wonder if they can just get a regular home loan instead of construction financing. The answer is yes, but only in certain scenarios.
One example is if you already own your own home and you have sufficient equity in the property. So, if you only owe $200,000 on your current property, but it has been valued at $600,000, then you have $400,000 in equity. In this scenario, you may be able to refinance your existing home loan to pay for the construction of your new home. Keep in mind that you can’t use your not-yet-built house as security for a home loan. Alternatively, if you already own the block of land and the land value on its own has sufficient equity, then you could potentially borrow against this instead.
The problem with financing a new home build with a typical mortgage is that you are being charged interest on the full balance of the loan from the very first day. This can be a substantial added cost if you’re already paying off a mortgage or you’re renting until the new home is built. In contrast, most lenders who extend construction finance loans will only charge for interest on the progress payments that have already been made. This makes it easier to manage repayments throughout the build.
What Paperwork Will I Need When Applying for a Construction Loan?
When you’re applying for construction loans, you’ll (first of all) need the standard documents required for a home loan application. These include things like proof of income and evidence of savings. Additionally, you’ll also be asked to supply:
- Project Plans: These plans don’t need to be approved by Council or a building surveyor, but they should be detailed enough that a valuer can determine the layout, size and design of your proposed new home.
- Project Specifications: The specifications should include what type of materials are going to be used to build the house (e.g., steel or timber frame? Colourbond or tiled roof?). They should also include a detailed list of what finishes you’ve chosen for the interior (e.g., tiles, appliances, bathroom fixtures, etc.). The project specifications help a lender to determine how much the property is likely to be worth once it has been completed.
- Building Contract: Under Queensland law, this doesn’t have to be a signed contract (so you aren’t being asked to commit to a project before you have finance approval). But the contract will need to show the overall cost of the project, the various stages of construction, any exclusions and the estimated build time.
- Quotes for Added Extras: Solar panels, extensive landscaping, pool installations or the construction of an outdoor entertaining area won’t typically be included in a building contract. If you want these additions to be covered by your construction finance, then you’ll need to include detailed quotes for these additional works.
How Does Construction Loan Financing Work?
As previously stated, a construction loan is structured with progressive drawdowns. These drawdowns are used to make progress payments to the builder when certain predetermined milestones are achieved. The progress payment schedule will be included in your building contract and the costs associated with each stage are typically calculated based on the percentage of works completed.
The 5 Stages of Building a New House
While progress payment schedules may vary between builders, there are typically five key stages when it comes to building a new house. These include:
Stage 1 – Base: This progress payment will be invoiced when the initial foundation for your home has been completed. It may include some excavation and levelling works, footings, pre-plumbing pipework and the pouring of a concrete slab.
Stage 2 – Frame: The next stage of construction involves putting up the frame for your new home. The frame stage will usually include framing for the external and internal walls, the installation of roof trusses, necessary bracing and the framing out of door and window cavities.
Stage 3 – Lockup: Once the frame is finished the builders will start closing up the building (getting it ready to ‘lock up’). This will include building the external walls, installing the roof cladding and fitting doors and windows into the frame. Once the building is secured (so no one can access it without a key), then lockup is complete.
Stage 4 – Fixing: The fixing stage refers to the internal carpentry (such as fitting door jambs, skirting boards and architraves) plus the installation of fixtures and finishes. This is the stage where you’ll see plastering, painting, cabinetry, tiling, carpet laying and other interior design elements. The fixing stage will also involve licensed trades such as plumbers and electricians.
Stage 5 – Completion: The completion payment will be invoiced once the house is completely finished. It covers any finishing touch-ups and the final clean of the building.
How is the Construction Progress Payment Schedule Calculated?
Although building progress payment schedules can be customised to suit the scope of works, most Queensland builders will use the schedule set out in the HIA New Homes Construction Contract. This contract recommends the following progress payment schedule for new houses being built in Queensland:
- Initial deposit: 5% of the contract total
- Base stage complete: 15% of the contract total
- Frame stage complete: 20% of the contract total
- Lockup stage complete: 25% of the contract total
- Fixing stage complete: 20% of the contract total
- Project completed: Remaining 15% of the contract total
Builders may sometimes change the percentages of progress payments so that the bulk of the cost is paid earlier in the project. This reduces the risk for the builder but increases the risk for the lender (if something goes wrong with the project part-way through). Because of this, some lenders may object if builders make substantial changes to the HIA recommended progress payment schedule.
Once the construction finance has been approved, the builder will need to provide the lender with an approved Council building plan, a copy of the project insurance policy and a finalised drawdown schedule.
How are Construction Loans Payments Made?
As your builder completes each stage of the building project, they will issue you with a progress payment invoice. This invoice should be forwarded to your lender with a request for a drawdown on the construction loan. Your lender can then arrange for each progress payment to be transferred directly to the builder (typically within 5 business days of the request being received).
However, some lenders will want to verify that the works have been completed to the satisfaction of an independent valuer before they’re willing to make payment. This acts as a protection for you, as it ensures you’re not paying for works that haven’t yet been completed. But it can also create minor delays in the project.
How is Interest Calculated on Construction Finance Loans?
With an interest-only construction finance loan, your lender will only charge you interest on the progress payments that have already been paid. For example, although the total cost of the loan may be $275,000, you’ll only be charged interest on $13,750 (or 5%) after the deposit has been paid (if using the HIA recommended progress payment schedule). After the base stage is complete, you’d be charged interest on $55,000, or 20% of the total loan (5% deposit + 15% base stage progress payment).
With this kind of loan structure, the amount of interest charged will gradually increase with time. This minimises the amount of interest that you will have to pay throughout the build.
Once the construction is completed you may have the option to continue with an interest-only loan for a period of time. But more likely, your construction finance loan will change to a principal and interest repayment structure (where you’ll start paying back the balance of the money borrowed, not just the interest). It’s a good idea to be familiar with your loan structure (and any scheduled changes) from the very beginning so you don’t end up with any unexpected surprises once you’re ready to move into your brand-new home. An experienced construction finance mortgage broker will be able to talk you through the various pros and cons of different loan structures and answer any lingering questions that you may have.
Does All Major Lenders Offer Construction Loans?
Construction loans are available from most of the big banks. However, just like with any loan, it’s important to carefully consider all of the relevant details (including fees, charges, interest rates, conditions and loan features) prior to making a final decision. A construction finance mortgage broker will be able to compare lenders and construction finance products to determine which construction loan is going to best suit your personal situation.
Currently, not all of the smaller lenders are offering construction finance options, likely because they come with a higher level of risk and are more labour-intensive for the lender to process and manage.
How Can I Get a Construction Loan in Brisbane?
If you’re interested in applying for a construction loan in Brisbane, then start by talking to a Brisbane mortgage broker. A mortgage broker can explain what options you have available to you when it comes to financing the construction of your new home and which loan products will offer the best solution. Additionally, when you talk to a construction finance broker you’re covered by ‘Best Interests Duty’. This legislation (which doesn’t apply to banks) ensures that a broker is always working in your best interests, giving you total peace of mind that you can trust their advice.
If you’ve been thinking of building a home with a construction loan, but don’t know where to start and want someone who knows the market well enough, North Brisbane Home Loans experts can help.