What is a Construction Loan?
When buying an established home, a regular home loan is used. The entire lump sum is drawn initially to pay for the house when the contract is signed and the balance of the loan is paid off over time by the home buyer. Regular home loans are in this regards fairly straightforward and beneficial to all parties.
When building a property, however, this kind of loan structure is less favourable to the borrower. Construction takes place in stages and as the homeowner can’t move in until the house is completed, paying a loan for a finished house when it is actually still under construction doesn’t make any sense.
This is what the construction loan is for.
With this type of loan, the balance of the loan is released in stages as construction proceeds. Each major phase of construction is funded in a separate draw down and as the next milestone is reached the next portion of the funds is released.
Common stages will vary depending on lender but may be:
- Slab down
- Frame up
- Brick work completed
- Lock up
- Final completion
This type of phased loan structure helps ensure the homeowner that construction proceeds smoothly and that they aren’t paying for what hasn’t been built yet. Interest is only calculated on the funds released. During the construction period, the homeowner does not have the burden of paying for a completed house.
When construction is finished and the contract is signed, the rest of the funds are released and the loans converts to a regular home loan.
With a construction loan the lender may have further stipulations or requirements. The homeowner will need to provide them with council-approved plans, proof of insurance, and a fixed price contract from a registered builder.
The construction will need to be finished within a certain period, usually 6 months from when the loan commences. Any equity of the buyer must be used first before the loan is drawn down. In addition, the work may be verified through inspections each milestone before the next stage of funds is released..
A Good Builder
With a construction loan a lot depends on your builder being reliable and true to their word. If costs end up running over the contract or if the construction period goes beyond the loan term, you’ll end up paying out of pocket.
This is why it’s important to go with a licensed and reputable builder that has a history of good work. Check their references and see if they complete builds on time. Construction loans are a great way for homeowners to save money during the building process and protect themselves at the same time.
Different lenders will have different requirements, stages, and features on their construction loans so it pays to shop around for the best possible deal.
If you have any questions about construction loans, home loans in general or the home building process, contact First Home Owners Centre today and our friendly representatives will answer all your questions.