3 Must Knows for Construction Loans
If you are thinking of building your own home, you will need to be familiar with the ins and outs of construction loans.
Construction loans are not as straightforward as simple home loans where there is an established home in place.
There are additional decisions to be made about the structure of the loan, additional documentation is required and the funding is released in an entirely different way.
1) The Application Process and Documentation
When you apply for a loan, the bank or lender will need a copy of the building contract/tender and the plans. They’ll ask their valuer to estimate the on-completion value (the realised value or end valuation) of the property and will assess your loan on the lesser of the land price plus cost of construction or the on-completion value.
- In addition to documentation about your finances, income and identity, your application for a construction loan needs to include contracts or tenders for the construction, as well as the plans so that a valuation can be performed.
- Further documentation will also be required before the first payment is made from the lender to the builder, including a schedule of the payments to be made (called drawdowns), the builders’ insurance details and the final plans that have been approved by the local council.
Once your loan has been approved, the lender will issue a loan document for you to sign and return.
Key Progress Stages of a Build
The loan draw downs are often referred to as ‘progress payments’, and they are typically made at six important stages of construction:
1. Preparation: This is the preparation stage when your builder will organise council approvals, source materials and line up a team of skilled tradespeople so that work on your project can commence.
2. Slab (or base floor): At this stage the site for your home is prepared and the concrete slab (also known as a ‘pad’) is poured. Depending on the nature of your block of land, this stage may also involve levelling the land and constructing retaining walls.
3. Frame: This is where your new home starts to become a reality. Teams of carpenters will work to erect the wall frames and roof trusses giving you an idea of how your home will look.
4. Lock up: This is always an exciting stage as your home is really beginning to take shape. The walls are bricked and the roofing is complete. Windows and doors will be fitted so that your home is weatherproof and can be securely locked when the builders depart each evening.
5. Fit out: This will see the installation of your choice of bathroom, kitchen and laundry. Walls will be painted in your choice of colours, tiles will be set and floor coverings laid. By now you’ll be eager to move into the new building and make it your home!
6. Completion: You’re on the home stretch now.
All that remains is for appliances to be installed and landscaping completed if this is included in your building contract. Once these are finished, your builder will walk through the property with you to ensure everything is completed to your satisfaction.
A representative of your local council will inspect your home one last time to check that it complies with the relevant building codes.
2) The Correct Structure
if you are buying bare land, to avoid having to contribute your full deposit and being charged interest on the entire loan amount from the moment the land purchase settles, you can split your mortgage into a land loan and a construction loan.
At settlement of the land purchase, you pay lender’s mortgage insurance (LMI) on the land loan, if LMI applies, and start being charged interest and making repayments on the balance of the land loan. The interest and repayments on the construction portion then kick in only as each drawdown is processed.
Using an investment structure
If you are an investor and are planning to undertake a property development and future investments, a Trust and Company structure may be suitable to use for asset protection and tax planning benefits, especially if you have a view to long term investing.
It is probable, but not certain, that any particular investment will do better owned by a tax efficient structure, such as a family trust, a company owned by a family trust or a SMSF.
Read more about Trusts and Companies here:
The drawdown schedule is very important, as you don’t start paying interest on each portion of the loan until it is paid to the builder – you, the lender and the builder need to be satisfied with the schedule.
When your builder is ready to begin receiving payments from the bank they will need to provide additional documents, such as the final council approved plans, his insurance & progress schedule for the build.
How do you request that the bank pay your builder?
- The builder will send you an invoice for the stage of the construction
- You’ll then complete and sign a drawdown request form (available from your broker).
- Send the drawdown request form and the invoice to the broker, who add any covering notes and pass it onto the bank.
- The lender may require a valuation to confirm the work that has been completed so far.
- The funds will be advanced to your builder generally within 3-5 working days.
- Repeat this process for each progress payment required by the builder.
- There are usually 6 key stages of the build these are explored below.
For the lender to make each payment to the builder, you will need to fill out a drawdown request form from your lender, and submit it to your builder. The builder can then send the lender your form with an invoice for that part of the payment and, after the lender is satisfied that the work has been completed and is up to the standard expected in the valuation, the drawdown can be completed with a payment to the builder.
Any major changes to the contract and plans can trigger a reassessment of the loan, so be as sure as you can be that the plans and contracts the lender sees are final, and it is also worth trying to pay for any small amendments from your own pocket, rather than changing the loan and risking a reassessment.
Problems can also arise when other work on the site that isn’t completed by the builder needs to be paid for, as some lenders only make the remaining funds of the mortgage available after the completion of construction.
While some builders will include subcontractors as part of the main contract, meaning that they can be paid by the builder as stages of work are complete throughout the drawdown schedule, others will not do this. Again, this may make it necessary to pay from your own pocket.
HOW WE SUPPORT CLIENTS
At Aspiire Mortgage Brokers, we assist clients with:
- Home Loans
- Construction loans
- Investment Loans
- Debt Consolidation
- Commercial Loans
- Rapid Debt Reduction strategies