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How do home loans for construction work?

Home loans that could give you the flexibility you need if you are building a new home or doing a major renovation.

How do home loans for construction work?

07 May 2024

Home loans for construction are a home loan option designed for people who are building a home from scratch or undergoing a major renovation. They give the borrower (owner occupier or investor) the flexibility to draw down their home loan in stages, as the project reaches certain milestones. 

The construction option is not a separate loan, it’s a feature available on the RAMS Full Feature, Fixed Rate, Fixed Rate Classic and Essential home loans. It could give you the added flexibility you need if you’re building a new home or doing a major reno.

How a construction loan option is different

With a standard home loan, home buyers usually draw down the full amount they are borrowing to pay for their new property. They begin making loan repayments and pay interest on the full amount owed.

With a construction loan option added to your home loan, instead of borrowing the full loan amount as a lump sum at the beginning of the loan term, you draw down in stages and make progress payments to the builder as each pre-agreed milestone is met.

You only pay interest on the amount that has been drawn down through the progress payments that have been paid – not the full loan amount.  

The home loan for construction process

Once you have a plan for your new home and have found a reputable, licensed builder to help you do the job, you might consider applying for a home loan for construction. The application process may vary between lenders. Typically, you’ll need to apply and get approval before the builders start work: 

1.  Construction Option application and approval (as part of a home loan)

As well as the regular home loan application information, you’ll be asked to supply documents outlining the renovation or construction process and to help estimate the value of the build at completion. The information you will need usually includes: 

  • Fixed Price Building Contract from a licenced builder, including an acceptable Progress Payment Schedule (following the key stages of the build)
  • plans (with council approvals as necessary)
  • quotes for extra work that’s not part of the main contract, e.g. landscaping
  • receipts for any deposits paid to the builder
  • builder’s licence, public liability insurance and bank details
  • Homeowner’s Warranty insurance.

Note that if your project requires funds upfront, for example, for your builder or architect to issue building plans, you’ll need to cover these costs yourself. 

2.  You’ll be issued with an ‘Authority to Commence Construction’ (ATC) certificate

If your documentation is in order and you get loan approval, the lender will issue an ATC certificate. This means work on your dream home can start.  Some builders ask for a deposit before starting. In many cases, this can be released up-front as part of the construction option.

3.  Progress payments and build stages

Only after a stage of the Progress Payment Schedule has been satisfactorily completed will the lender release that stage’s funds to pay the builder.
The specific stages of the Progress Payment Schedule will depend on the type of work undertaken. When building a new home, the stages of construction might include:

  • builder’s deposit – to confirm the job
  • base slab – foundations, footings, base brickwork
  • frame
  • lock up – roofing, external walls, windows and doors and insulation
  • fit out – internal walls, plastering, plumbing, electricity, cupboards, tiling
  • final stage completion – clearing the site, fences etc.

4.  Final stage completion

Before the final set of funds can be released, your lender will want to be sure specific build criteria have been met. With RAMS, that means final payment is subject to an ‘at completion’ valuation (done at no cost to you), a Certificate of Occupancy, as well as a comprehensive building insurance policy. 

Calculating the cost of your new build or renovation

If you’re looking to work out the costs of your construction project or renovation, we have two calculators that could help:

  1. Our construction calculator can give you an estimate of construction costs based on the location and your building preferences (such as size, style and materials), to help you figure out how much you’ll need to borrow.
  2. Once you know how much you need to borrow, our repayments calculator can estimate what your repayments will be. During the construction period, you will pay interest-only repayments – so don’t forget to set the repayments to ‘interest only’.

Construction loan benefits

A construction loan option on your home loan could help maintain cash flow for your builder and keep the project’s funding on track, giving you:

  • control – you pay the builder in stages, only for the work that’s completed (progress payments)
  • savings – during the building process, you only pay interest on the amount you’ve drawn down, not on the full loan amount 
  • flexibility – you won’t be charged interest for incomplete stages if there are delays
  • simplicity – as an option on an existing home loan, there’s only one loan to deal with
  • cash flow – with RAMS, Construction Option repayments are calculated as interest-only, which helps lower repayments during the construction phase
  • proven process – the construction option process is straightforward, helping you stay on top of finances when working with a builder.

It’s important to remember that even with a construction option, you’ll still be charged interest for the full loan amount that’s owing on the property or land itself.

Construction loan considerations

  • There may be minimum loan amounts, so this option might not be right for smaller renovation and building projects (RAMS’ minimum home loan option is $15,000). 
  • Because not all home loans offer a construction loan option, you’ll need to choose a loan that does or refinance to one that does.
  • While the specifics will depend on the lender, there are other conditions you’ll need to meet to qualify. For instance, RAMS doesn’t currently offer a construction option to owner-builders or to refinance partly completed construction projects.

Remember, you’ll still need to pay a deposit – just like you would with a standard home loan. At RAMS, the maximum loan-to-value ratio (LVR) for a home loan is 95%, but at that level, you will need to pay lenders mortgage insurance (LMI).   

Who is a home loan for construction best for? 

Building your first home, dream home or doing major renovations on your property is a big project, but it can be rewarding. Whether this option is right for you depends on your personal and financial situation – it’s a good idea to seek professional advice before you get started. 

The construction option is available on many RAMS home loans and it can be used for:

  • purchasing land and building a property (to occupy or as investment property)
  • financing construction on land you already own
  • refinancing a land loan and building a property, or carrying out major renovations for owner-occupier property (with RAMS, the min. loan amount is $15,000).

RAMS does not offer construction loans to Owner Builders, for Kit Homes, builders’ spec houses, project finance or developments. 

For more information see our construction FAQs.

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