How Does A Construction Loan Work?

A construction loan is becoming an increasingly popular financing choice for Aussie homeowners. Wondering exactly what they are or how they work? Too easy – Monzi is here to explain everything.

Please note, certain ideas and products presented in this article may not be offered by Monzi nor the lenders we work with. This article presents only general information. Consider seeking professional financial, taxation, legal or other advice to check how the information and ideas presented on this website relate to your unique circumstances.

What is a construction loan?

A construction loan is a type of home financing designed for people who are building their home instead of purchasing an existing property. Moreover, these loans are structured differently to a typical mortgage.

Most loans for construction come with progress payments, or a progressive drawn down. In other words, your lender will dispense funds as construction progresses. As your build continues, you can increase your borrowing, or draw down the loan.

In addition, consumers generally only repay interest over the first 12 months of their loan term. At the end of this term, your loan will revert to standard repayments (interest and principal).

The amount you’re eligible for is often based on the perceived value of the finished property.

Construction loans – how they work

Construction home loans work quite differently from normal home loans. After all, the intended purpose of a loan for construction is very different.

As we mentioned earlier, lenders offering construction home loans release payments at certain stages throughout the build. In general, payments are made once a stage is complete. There are, specifically, five stages of construction:

  1. Base. These funds are designed to help you lay the foundations of your property.
  2. Frame. This payment will cover the frame of your property. This includes brickwork, roofing, windows etc.
  3. Lockup. Builders erect external walls, windows and doors to ‘lock up’ the structure.
  4. Fitout. This stage of the build covers internal fittings. The money your lender dispenses at this stage covers things like plasterboard, the beginning of cabinets and wardrobes, plumbing, electricity etc.
  5. Completion. Covers the cost of contracted items, like builders, equipment, subcontractors etc.

Construction home loan comparison

Picking the right lender for your loan is important. Moreover, how you compare different loan options will have a huge impact on the value you get out of it.

Consider the following when comparing construction home loans:

  • Interest. Obviously, the interest rate on your loan will go a long way to determine the overall cost of your loan. Bear in mind, there is generally an interest-only period for construction home loans, where your repayments will only pay down the interest, not the principal. Finally, the interest rate may not include all the additional fees and charges. Therefore, the comparison rate may be a truer reflection of the cost of your loan.
  • Fees. These loans may have additional fees to cover the charge of having your property evaluated after each stage of the build.
  • Loan features. The features of your loan (redraw, additional repayments etc.) are generally unavailable during the construction phase. Once your home is built, however, your loan features should become available.
  • Construction terms. Includes how long you are given to build using the loan, as well as the process for drawing down additional funds.

How much deposit do I need for construction loans?

Due to the nature of these loans, there is a number of risks involved for the credit provider. As a result, the eligibility criteria for construction loans are often stricter than traditional lenders. In addition, lenders often require you to put down a sizeable deposit.

While lenders may all vary in terms of what deposit they require, most will require at last 20% of the total cost.

Do I need a good credit score for construction home loans?

In general, yes; you will need a good credit score to be approved for a loan for construction.

The level of risk posed to lenders on a construction home loan is generally much higher than that of a traditional home loan. After all, borrowers will make interest-only repayments over the first 12 months.

For more information, head to our article on construction loan repayment calculator.

Loan for renovation

Loans for construction may also be an option worth considering if you are looking to renovate your property. The amount you may be eligible for will often be based on the estimated post-renovation value of your property.

In addition to this, you may even be able to use these loans to make some upgrades. For instance, some lenders may offer swimming pool finance so that you can stay cool this summer.

How do I get these loans?

Be aware that the application process for these loans is different from a normal mortgage.

  1. Present the lender with the design plans for your property.
  2. The lender considers these plans and aims to determine the expected value of the completed property. Moreover, the lender will also take into account the total amount of money required to pay the builder.
  3. Lenders will crunch some numbers and make you an offer.
  4. If you agree, you will need to make a downpayment. Depending on your circumstances, this could be up to 20%.

Are construction loans hard to get?

It may be more difficult to qualify for these loans than a traditional home loan. This is because loans for construction pose a higher level of risk to lenders.

These loans may be harder to qualify for because you:

  • will generally need to have good credit history
  • need to provide professional design plans when you apply
  • will need to put down a sizeable deposit – sometimes upwards of 20%.

Ultimately, your personal situation, as well as your lender’s criteria, determine how difficult it is to be approved.

Construction loan silhouettes of builders and crane

What does Monzi do?

Monzi is a lender-finder that specialises in trying to match Aussie consumers with potential lenders offering flexible loans for personal expenses. We cannot help you with any sort of construction or home loan. However, if you’re looking for a lender offering personal loans, we might be able to help.

The below table shows examples of the loans potentially available through our network of lenders.

Bad credit loansSmall loans
Short term loansCash loans
Easy loansSame day loans
Quick cash loansInstant cash loans Australia

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Finally, check out the MoneySmart website’s article on personal loans.

Factor In

Costs

Two credit cards
Two credit cards

You won't use a penny to apply for our lender-finding service, but here's some costs you could expect from a lender

Loan amount

$300 - $2,000

Terms

12 months

Costs

20% upfront establishment fee

+ 4% monthly fee

Example

Loan Amount of $1,000 over 6 months repayable weekly (25 weekly repayments). $1,000 (Principal Amount) + $200 (20% Establishment Fee) + $240 (fees based on 4% per month over 25 weeks) = $1,440 total repayable in 25 weekly installments of $57.60.

Under the current legislation, most small personal loan providers don’t charge an annual interest rate (you’ll know this as an APR) %. The maximum you will be charged is a flat 20% Establishment Fee and a flat 4% Monthly Fee. The maximum comparison rate on loans between $300 and $2000 is 199.43%. This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate

Loan amount

$2,001 - $4,600

Terms

13 months

24 months

Costs

48% annual percantage rate

67.41% comparison rate p.a.

Example

Loan Amount of $3,000 over 18 months repayable weekly (78 weekly repayments). $3,000 (Principle Amount) + $400 (Establishment Fee) + $1,379.06 (reducing interest) = $4,779.06 total repayable over 18 months with weekly installments of $61.27.

The Interest Rate for Secured Medium Loans is 48%. The Typical Comparison Rate is 67.41% p.a. WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate with the lender that finances your loan. Click here to see a worked example.

Loan amount

$5,000 - $10,000

Terms

13 months

24 months

Costs

21.24% annual percantage rate

48% comparison rate p.a.

Example

Loan Amount of $10,000 over 24 months repayable weekly (104 weekly repayments). $10,000 (Principle Amount) + $5,577.12 (Interest) = $15,577.12 total repayable over 24 months with weekly installments of $149.78.

The Interest Rate for Secured Large Amount Loans is 48%. Maximum Comparison Rate is 48% p.a. WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate with the lender that finances your loan. Click here to see a worked example.