Your Guide to Construction Loans
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The Borrowers Guide to Construction Loans has been designed to assist consumers gain a better understanding on how the construction lending process works and the specifics associated with construction lending and building a home.
The process can be confusing and overwhelming at times, but when you understand the basic process, you will be much more prepared.
Talk to your Mortgage Broker!
Your Mortgage Broker is here to assist you navigate this complicated process so it is important to engage them early in the process.
Your Mortgage Broker will:
Discuss your existing situation, your lending needs, requirements and obtain all necessary information pertaining to your lending application.
Explain the types of loans available to you from a range of banks and specialist lending institutions.
Based on the information provided by you and utilising specialist lending software, match your lending requirements to a selection of loan products offered by a diverse range of lenders.
Provide an overview of the relevant costs associated with your loan application.
Provide an in-depth overview of the loan product or products you select.
Act as an intermediary between you and the lender by completing and packaging your loan application.
Liaise with your solicitor, real estate agent, accountant and any other related party to ensure a smooth and timely settlement.
Assist you in lodging your progress payment claims with the lender.
Assist with any future lending requirements, whether you wish to check, change or top-up your loan.
Before you start looking for a home or investment property, there are several key details to consider such as:
Your income
This includes your fixed remuneration and any bonuses or allowances you receive. It is important when discussing your income with your Mortgage Broker that you disclose the types of income as some lenders may assess different types of income at different rates. As an example, your overtime might only be assessed at 80% of your income, but if you were in essential services it may be assessed at 100%.
Your Financial Liabilities
This includes things such as credit cards, personal or car loan and HECS debt. It also includes After Pay and Zip Pay and any interest free loans you may have. Credit cards with no debt owing but still active also need to be disclosed.
Your Living Expenses
Mortgage Brokers and lenders have an obligation to ensure they are not putting you into a loan that would cause you undue hardship. A key factor in assessing this is reviewing your living expenses. This is normally done by assessing your last 3-6 months transaction and credit card statements to assess how and where you spend your money. One of the key benefits of working with your Mortgage Broker before you are ready to buy a property is that they can help you identify any changes in your spending habits that you could make to provide a more favourable view to the lender.
There are many options available in relation to how much you will need to come up with as a deposit.
Depending on your situation it could vary from 5%-20%. Sitting down with your trusted Mortgage Broker will ensure you know which options are available to you.
Most lenders will want to see evidence of consistent savings over a period of 3-6 months. This is to not only show that you have the funds to complete the transaction, but that you also have the discipline and commitment to pay your ongoing mortgage repayments once you settle your loan.
The amount of the deposit can be varied, some lenders will allow you to borrow up to 95% of the value of the property requiring you to only have 5% of the value of the property saved. This will require you to pay Lenders Mortgage Insurance (LMI). LMI is a cost which you, the borrower, pay at the settlement of your loan that protects the bank in case you default on the loan and they must sell the property at a loss. It is important to understand that LMI does not protect you if you get sick or lose your job. To avoid paying LMI you generally need to borrow less than 80% of the value of the property.
The cost involved in purchasing a property is more than just the purchase price and can include such things as:
Bank Fees
This includes any application or valuation charges and can vary between lenders.
Stamp duty
This is a government cost that is usually the biggest expense outside the purchase
price of the property. Stamp duty varies between the states and territory. Your Mortgage Broker can assist you in calculating this amount.
Lenders Mortgage insurance
Insurance
This is a cost to you, the borrower, that is generally charged by the bank if you have less than a 20% deposit on the property. It can vary between lenders and your Mortgage Broker can assist you in calculating this amount.
Government fees
These include things such as mortgage registration, transfer fees and title searches.
Legal Costs Either a conveyancer or solicitor will review your Contract of Sale and ensure appropriate checks are conducted on the property with local government agencies.
Property Checks
It is always recommended that prior to purchasing a property, you hire professionals to inspect the property for structural defects, concerns, pest infestations, anything that could potentially cause damage to your property.
Removalist Costs
Will you do this yourself or hire a company?
Utilities
Set up of utilities which may include a connection fee and up to 2 months of charges as they may charge in advance.
The amount you can borrow will depend on several factors and is another reason why it
is important to engage your Mortgage Broker in the process BEFORE you are wanting to buy a house. Your borrowing capacity will depend on several factors including:
Fixed Rate Home Loan
A fixed rate simply means that the interest
rate is guaranteed for a certain amount of time
– commonly between 1 year to 5 years.
The benefits of a fixed rate loan are that you
know what your repayments will be over a specific
time frame and you can budget accordingly. The
interest rate is not going to go up (or down)
over that period.
The disadvantage however is that fixed rates loans
are not very flexible. There will be a limit to the
amount extra you can pay off over the fixed term
and fixed rate loans rarely allow you to redraw
any surplus funds or have an offset account. The
other thing to be aware of is that if you have to
sell the property during the fixed rate period, you
may incur break costs which could run into the
1000’s of dollars
Interest Only Home Loan
An interest only loan is where the borrower only
has to pay the interest accrued each month on
the loan, rather than paying down the principle
balance. Usually it is associated with investment
properties in line with a strategy from the
accountant or financial planner.
The benefits are that the repayment is reduced,
thus freeing up cash for other purposes however,
the principle will still need to be repaid and once
the interest only period is over you will be paying
off the principle at higher repayments than you
would if you started paying the principle off from
the beginning.
Variable Rate Home Loan
A variable rate means that the interest rate will rise
and fall with the market over the period of your
home loan. This can be in line with movements
in the official cash rate by the Reserve Bank or it
may be a decision by your financial institution to
vary their rates.
The main advantage of a variable rate loan is
flexibility. While you must meet your minimum
monthly repayment, you can usually pay more if
you want to. There is also no cost penalty if you
decide to sell your property and move. You also
generally can have access to an offset account,
redraw or both.
The main disadvantage of a variable rate loan is
that your minimum repayment amount may rise
or fall at any time in line with either the Reserve
Bank or a business decision by your financial
institution. This can make it hard to plan especially
for those on a tight budget.
Split Home Loan
A split loan offers the best of both, offering
the certainty of a fixed rate and the flexibility
of a variable rate.
Before you can build your house, you need some place to build it. Buying the land is the first step on the road to building your new home and there are a couple of different ways this can take place.
DIY Land and Construction
You may find a block of land that you like, make
an offer on it, have it accepted and then need to
go and find the builder of your choice to build on
that block for you. This is a good option if you are
looking for something highly customised or you
are wanting to wait a bit before building.
House and Land Package
This is the process where you secure both the
land and construction at the same time but
through two separate contracts. Generally, there
are a select number of builders and designs that
are on offer in this scenario and you can choose
from them and make minor amendments.
The Construction Loan is a loan that is drawn
down in stages as your property is being built.
This means that your monthly mortgage
repayments slowly increase as the construction
moves forward until finally at completion of
construction the loan repayment reaches its full
monthly repayment amount. This process is helpful
as you may still be paying rent or board at another
location while your home is being built.
Most lenders also offer interest only repayments
during the construction process which revert
to principle and interest repayments once the
construction is complete.
To qualify for a Construction Loan, you will need
to have council approved plans and a fixed price
building contract or a tender from a licensed
builder.
This can be a challenge as you don’t want to sign
the building contract until you have approval from
the bank that you can borrow the money but
they need a contract to assess your loan. There
are several solutions to this problem including
negotiating a finance clause of at least 3 weeks
into your contract or providing a draft contract.
Some banks will provide approval on a tender but
the problem here is things often change between
the tender and contract stage and you would then
require the bank to reassess.
You should also note that you will need to use
your saved funds or equity before drawing down
on your Construction Loan.
Always check with your Mortgage Broker if you
would like to make any variations to your building
contract, prior to proceeding.
Upon completion of your property, the
Construction Loan usually reverts to a standard
variable rate home loan.
Many Construction Loans have approximately
five draw downs. These drawdowns are often at
the following stages but may vary depending on
your building contract:
Generally speaking the bank will instruct the valuer to review the value of the land, (either from the Contract of Sale or from their own valuation if you already own the property) and the cost of building the house from the construction contract and specification. They will then assess it in comparison with the value of other similar houses in the area.
The result will either be the cost of the land plus the value of the improvements or the valuation amount in comparison to other properties in the area, whichever is the lowest.
In addition to your standard documents relating to income, expenses and other debts, you will also need to provide the following:
Building Contract
This includes things such as the building stages, the drawdown schedule, how long construction should take and the final price.
Building Plans
This is the specific drawing that outline what it is you are building, they don’t need to be council approved at this point but are required to provide the valuer with an idea of what it is you are building.
Specifications
This outlines the type of materials you are using including the quality of the finishing’s and appliances.
Quotes for additional work
It is important to read your building contract carefully as sometimes there are things not included and you may have to get quotes for these additional works.Typical things not included could be:
- Swimming pools
- Shed
- Landscaping and retaining walls
- Driveway
- Fencing
Once your loan has been approved and you have provided the approval to your builder, they will start the process of finalising the plans and sending them to council for approval.
Once this is completed, you will need to provide the following to the bank prior to them releasing funds for the construction:
- Signed Contract (fully signed by builder and purchaser)
- Signed Specifications (fully signed by builder and purchaser)
- Council Approved Plans
- Builders Risk Insurance
- Arrange insurance covering the full replacement value and ensure that your lender is listed as Mortgagee.
You may decide that you have the skills and resources to either build your home yourself or manage the process, this is called an Owner Builder. Whilst there are the obvious advantages of saving money and building the house exactly to your specifications, there are some things you need to take into consideration before you proceed down this path.
Level of Experience
Whilst you are not required to be a licensed builder to get an Owner Builder license, the majority of the lenders now will require you to have experience building a home before they would lend to you in an Owner Builder scenario.
Loan to Value Ratio
The banks consider Owner Builder lending to be higher risk and as a result will lend a lower loan to value ratio, generally around 60-65%. This means you would need to have significantly more equity or cash in the project before they would consider you.
Cashflow
Like a standard construction loan, the lender will only release the funds once the stage has been completed. They will generally send a valuer out to inspect the progress and if satisfied, release the funds to you. The challenge this can present is that you need to have the cashflow to pay for things before the bank reimburses you, so having funds to complete is imperative.
Speak to your Mortgage Broker to find out more
about if Owner Builder would be right for you.
To ensure you have the best experience possible, we have provided a few handy checklists:
Required Documents Checklist
This will allow you to prepare for your first meeting with your Mortgage Broker and ensure you have the right documents ready, to avoid delay.
Budget
It is important to understand what you spend and what you can afford. Your Mortgage Broker will review this with you, but this document will help get you started.
Preparing for Settlement Checklist
There is a lot to think of when you are buying your home and this will assist you in ensuring there are no delays on settlement day.
Download the complete PDF document containing the checklist of required documents.
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