A Guide To Construction Loans In Australia

If you’ve never built a home before or are embarking on major renovations for the first time, you may not be aware of all the different loan types available to you.

For many Australians, a construction loan is the best choice in these scenarios, as they involve progress payments that may streamline the lending process for you.

Construction loans may not be for everyone though, which is why this guide will help clarify what the loan entails so you can make the right decision for you.

Once you know what you need, you can get started finding a construction loan.

What is a construction loan?

A construction home loan is a type of loan that is most suitable for Australians who are either building a brand-new home from scratch, or making major renovations to an existing property.

Unlike your average home loan – which can only be taken out when you are purchasing an existing property – a construction loan can only be used to build or extensively renovate a property, because it covers your expenses in stages as your building project progresses. Bank valuers base your loan size on the potential value of the finished project. You still need a deposit to take out a construction loan, and it’s similar to a regular home loan in this way.

The construction period is usually paid in stages and is interest only. Once your building is completed, your regular loan structure commences.

For example, if your home loan is principal and interest for 30 years, this loan begins as soon as your interest only construction loan completes. 

How are construction loans different from typical mortgages? 

Aside from the fact that both a construction loan and a traditional home loan are used to cover the costs of purchasing or building a home, they serve very different purposes.

First, a construction loan cannot be used to buy an established property. It can only be taken out to cover the costs of building a new home (or undertaking major renovations).

Also, the life of a construction loan only covers the amount of time it takes to finish the project, whereas a regular mortgage generally lasts several decades.

The biggest difference, however, is that a lender will provide the entirety of a regular home loan at settlement.

A construction loan doesn’t pay out a lump sum – instead, the loan amount is delivered in progress payments at certain stages, according to how your construction proceeds.

How much can you borrow with a construction loan?

The amount you borrow for a construction loan ultimately depends on the lender you decide to go with, and the projected finished value of your building project.

Some lenders will allow you to borrow up to 95% of your construction costs – meaning you will need to have at least 5% of the build costs saved.

However, bear in mind that you may need to pay lenders mortgage insurance (LMI) if you have a deposit of less than 20%.

Find out more about LMI here.

If you have the bulk of your construction costs saved, lenders may be more willing to give you a lower interest rate, so make sure you compare construction loans to get the best deal possible. At Compare Club, we do this for you.

What are the interest rates like for a construction loan?

While some people may decide that taking out a personal loan for small renovations is the best way to go, bear in mind that you will be saddled with very high interest rates for such a loan.

Interest rates for construction loans, thankfully, are usually in line with traditional home loan rates.

As of December 2022, you’ll find that a range of lenders are offering construction loans with an interest rate of above 4%, similar to regular home loan rates. 

Can you combine a land purchase loan and a construction loan?

Yes, it’s possible to get a loan that covers both the purchase of your land and construction of your house.

Deciding whether you should take out two loans for the land and the building, or whether one will suffice, is a common consideration.

It ultimately depends on your own circumstances, as well as the funds you can provide upfront.

If you split the loans into both a land loan and a construction loan, this may allow the loan amount for the land to be delivered before the construction loan begins.

Combining the two into one loan, may assist cashflow while you build, as construction loans require interest only payments.

Is it harder to get a construction loan than a mortgage?

Depending on the lender you decide to go with, it may not be any harder to get a construction loan than it would be to take out a traditional home loan (i.e. get a mortgage).

However, you do need to supply additional paperwork when applying for a construction loan.

 In addition to all the standard paperwork regarding your own finances – such as payslips, bank statements, cost of living, and any other debts you have – you also need to provide your building contract and your building plan.

You may also need to provide building specifications, which details the materials and finishes you plan to use for construction.

How do progress payments work?

As part of a construction loan, you’ll receive progress payments – also called draw-downs – rather than a lump-sum payout all at once. This allows you to only receive the necessary funding for each stage of construction.

Your lender will be involved throughout the entire building process, and they will probably visit the site before releasing each subsequent payment.

Generally, there are five stages of a construction loan, with a percentage of your total loan amount being released at each stage. These are:

1.    Slab down, or building the base of your home.

2.    Putting up the frame.

3.    Lock-up, which includes constructing the external walls, insulation and doors.

4.    Fit-out, which includes installation of all your home’s fixtures and fittings.

5.    Completion, which involves all the finishing touches such as painting, fencing and clean-up.

What are the risks of construction loans?

Because of their flexibility, segmented progress payments and short length of the loan, construction loans aren’t seen as being overly risky.

However, there are always risks associated with any loan, and new-home builds and renovations don’t always go to plan. It’s important to consider any risks and ensure a construction loan is the most appropriate solution for your needs.

Generally, the biggest risk of a construction loan is delays or building issues that can blow out your initial budget (such as bad weather, or late delivery of building supplies).

Your loan terms may have built-in safeguards for these scenarios, but it’s recommended that you have a financial buffer to cover any unforeseen expenditures.

There’s also a risk that your property may devalue during construction and/or since your land purchase, which may mean a lower loan amount needs to be renegotiated.

This can affect the timely completion of your project. While this risk is not common, it is more likely in this  climate of rising interest rates and inflation, than it used to be.

Working with a good broker means you can mitigate this risk in advance.

Where can I find the best construction loan?

Just like taking out a traditional home loan, you can speak to your preferred lender about taking out a construction loan. Comparing multiple lenders offers more options and allows you to find the best deal for your needs.  

With Compare Club, we scour construction loans from more than 40 different lenders to provide you with a range of excellent loan options for your specific circumstances.

Anthony Stevenson, is the head of home loans at Compare Club. With over a decade of experience under his belt, Anthony is dedicated to helping individuals make informed decisions when choosing a home loan. Whether it's finding a great deal on your home loan or refinancing, Anthony has a wealth of knowledge in the space.

Meet our home loans expert, Anthony Stevenson

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