Construction Loans Explained

Construction of a house can be divided into five stages:

• Purchase of the land.
• The floor.
• The roof.
• Lock up.
• Final.

To match these five stages the construction loan can be divided into five progressive draws. As one phase of the construction is complete, you draw down the next portion of the loan, meaning that interest is only calculated on the amount that you have physically drawn down, and you are only making repayments on the portion you have used. At the start of the loan you can specify which loan type you will revert to when construction is complete.

In the past most lenders would only lend around 60-65% of the land value for purchase, as a land loan. But now increasing numbers of lenders are now lending up to 90-95% of the land value. When you decide to build your home and you apply for a construction loan, you will need to provide the lender with copies of the council-approved plans and a fixed-price building contract before the construction loan can be approved.

If you have a land loan, and are also intending to apply for a construction loan, most lenders will only base the value of the loan package on the land value, plus the cost to build the house. Some lenders will lend on the estimated re-sale value of the completed dwelling and land at the current market value. You should check with various lenders if they do this, or ask your mortgage broker to refer you to lenders that offer this facility.

After each construction stage is completed, a valuer will usually inspect the property to check that construction has been completed in accordance with the requirements stipulated in the fixed-price building contract.  If these have been met, the valuer will authorise the next payment to your builder’s account.

If you feel that the construction is not going to schedule, and that you may need to pay your contractors prior to the completion of the construction phase, you can apply for a very small line of credit as part of your construction loan to cover the extra expenses. You can then pay your line of credit before the appropriate stage is completed and the money has been drawn down.

To lessen the financial burden during the construction phase, construction loans are normally interest only. The interest rate may be slightly higher than a standard variable home loan, but it will be less than a line of credit.

When the construction is complete, you can get the property revalued as a complete house and land package, and you may be able to increase the amount borrowed if you need to. This is because the completed land package will probably be worth more than the original valuation. Consequently you may be able to refinance or increase your loan amount based on an increased security value.

For information on mortgages go to http://www.creditworld.com.au/home-loans.html.

Summary

• Construction of a house is divided into five stages.
• There are five progressive stages of the construction loan.
• You only have to make repayments on the portion of the loan you have used.
• Most lenders will lend you 90-95% of the land value.
• When applying for the construction loan, the lender must sight the council-approved plans and the fixed-price building contract.
• After completion of construction, you may be able to revalue the property as a complete house and land package, meaning you may be able to refinance or increase your loan amount, as a result of the land’s increased security value.

Article correct at its author date: Jan 2007. Copyright Virtual Office Space, Any unauthorised reproduction of this article will be prosecuted to the full extent of the law. Credit Cards Australia.

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