Buying an existing home differs a lot from constructing one depending on your lifestyle and financial needs. Therefore, we should approach both types of loans differently. For instance, a regular home loan is suitable for purchasing an existing home, but a construction loan is the most practical option for building a new home.
But what is a construction loan? How does it work, how can you apply, and what benefit will you get? And what do you need to consider?
Construction Home Loans
Construction home loans, also called building loans, are an option for people who want to construct their home rather than buy an existing one. Unlike standard home loans, they operate differently, charging interest-only repayments throughout the building process. The interest-only period ensures that your repayments do not cost you a lot during construction. And you only pay interest on the drawn amount and not on the overall loan amount.
You can use construction home loans to either build a new home or renovate your existing home. While using these loans, you can access your money in different construction stages. This implies that you will receive your payments at each subsequent construction stage, referred to as progressive drawdowns.
Procedure to Get Approval for Construction Home Loans
So firstly, you must get approval for your construction loan, which will involve the following steps.
- Fulfil eligibility criteria: First, confirm your eligibility criteria, including being an Australian citizen aged 18, having a stable income, meeting the lender’s serviceability requirements, and holding a sufficient deposit.
- Prepare the required documents: Prepare all your necessary documents. These documents will include income proof, a loan application form, a building construction contract, land ownership proof, council-approved plans, insurance details of the builder, and a confirmation deposit.
- Get pre-approval: Before finalizing your plans, get your loan pre-approved. This procedure will let you plan further as per your budget and borrowing capacity.
- Obtain a fixed-price building contract: As lenders provide cost certainty, they prefer fixed-price contracts. So, get your contract done, highlighting total construction costs, payment schedule for progress draws, and other construction-related expenses.
- Conduct LVR assessment: Most lenders only approve construction loans, if LVR (loan-to-value ratio) stands at 80-90%. So, conduct an assessment to know your LVR and maintain 10-20% of a loan deposit beforehand.
- Final Loan Approval and Progressive Payments: After verifying all the details, lenders give the loan final approval, and you can proceed with progressive drawdowns. Further, once your home is built, your loan will convert into a standard mortgage with regular repayments.
How Does a Construction Home Loan Function?
Once you get your loan pre-approved based on your financial condition and construction plans, your lender will pay your builder in subsequent construction stages. Your builder will then tell you the overall construction costs by breaking them into segments. Meanwhile, you only need to pay interest on the amount drawn during the construction phase rather than the full loan amount.
Then, when your construction is complete, your loan will convert into a standard home loan with principal and interest repayments. However, you can choose between fixed/variable interest rates, depending on your lender’s offers.
Different Types of Construction Loans
There are varied types of construction loans that you can take advantage of depending on your construction project and financial situation.
- New Home/Knockdown Rebuild Construction Loans: These loans are mainly for those who want to build their homes from scratch.
- Renovation Loans: Anyone who wants to make major upgrades or repairs to his/her home can take out a renovation loan.
- Land and Construction Loans: With these loans, one can buy land and construct a home on it.
- Owner-Builder Loans: People who want to manage their home on their own prefer these types of loans.
Key Considerations While Applying for Construction Home Loans
Since construction loans are better suited to fulfilling your desire to construct your home yourself, you must consider certain things:
- Pre-Approval: Proceed with a home loan only when it gets approved. This stage is crucial as it allows you to understand your actual borrowing and repayment capacity. Lenders will assess your financial situation, including your income, expenses, and credit history, and then only give you final approval.
- Budget: With a thoughtful budget and a construction plan, you can assess the timeline of construction. This information will ultimately let you proactively assess the possible risks in the construction project and the overall money you need for them.
- Required Deposit: Most lenders require a down payment, so you must keep the required deposit between 10–20% of the overall construction project cost. This will ease in getting quick loan approval as lenders entrust your commitment to the project.
- LVR requirement: Construction loans often require a higher deposit than a standard one. So, check your LVR before proceeding with the loan such that if it is 80%, then keep a 20% deposit, exceeding this limit can lead you to pay LMI (Lender Mortgage Insurance).
- Timeframes: You must ensure that the construction begins within 12 months from the disclosed date on the contract. Additionally, it should be completed within 24 months of the first scheduled progress payment.
- Progress Inspections: Throughout the construction, getting your progress inspected by qualified professionals will help maintain safety standards.
- Insurance Details: Lenders often demand insurance details from you and your builder to safeguard both parties. So, you must make sure to prepare these details for a subtle loan approval process.
Are construction home loans the right choice for you?
Choosing a construction home loan depends largely on your financial needs. These loans can help you save more while making repayments. Moreover, you only need to pay interest on the amount drawn rather than the full amount. This procedure will subsequently help you manage your finances with minimum risks.
Additionally, lenders understand the complexity of construction projects and may offer favorable loan terms. As a result, you can construct your home peacefully with higher flexibility. Since some lenders allow borrowers to make additional payments, it helps them reduce the overall loan balance with lower future interest costs.
However, you may encounter risks like paying higher interest rates than standard home loans. It’s because lenders struggle to assess the value of a home that is not in existence. Variable rates can also influence the interest rates during the construction period. During any stage of the building process, such adjustments may unavoidably affect your financial security.
Furthermore, a delayed completion of your construction may affect your ability to repay your loan on time. No wonder the housing market is also volatile, which can restrict your ability to sell the property and refinance the loan.
Final Thoughts
Since construction loans involve both risks and benefits, you should take professional guidance. The right professional guidance can let you get the most out of these types of loans. It will help you know what potential risks you may come across in detail depending on your financial situation along with the key opportunities.
Consult Nfinity Financials, for more details on stabilizing your financial future with construction home loans or call us at 1300 GET LOAN or 0456 456 267.
