Whether you want to build your dream home from the ground up or would like to update some of its features, you may need something other than a traditional mortgage to finance your project. A construction loan could be the answer.

This type of loan may be ideal for property owners wanting to build or renovate on land they already own. A construction loan isn’t structured like a typical mortgage. Your lender will consider the total amount you need to borrow to pay your builder and then breaks down the full amount into separate payments.

This mortgage could be the ideal way to finance your renovation’s construction if you don’t have equity you could tap into. However, before you give your lender a call and submit your application, here are ten unique facts you need to know about construction loans:

  1. It has stages called drawdowns. The total amount of your construction loan is not given to you in a lump sum. As mentioned, your lender will give portions of your loan amount in progression. These are called draw-downs and they cover the following stages:
  • First stage: Slab down or base. The first drawdown could cover the cost of building the foundation of your home. It may be 10% of your contract and could take up to two weeks.
  • Second stage: Frame. Your lender could finance the building of your property’s frame; it could take 15% of your total contract. This stage may take up a month to be completed.
  • Third stage: Lock up. In this stage, your home’s external walls, doors, and insulation are built. It could get 35% of your contract and may take up to four weeks.
  • Fourth stage: Fixing or fit in. During this drawdown, your lender pays for all the fixtures. Plumbing and electrical systems may also be completed. This stage makes up 20% of your contract.
  • Fifth stage: Completion. This stage covers the finishing touches of your home like painting, fence installation, and polishing. This may take up to 15% of your total contract.
  1. The interest you have to pay could be less. With this type of mortgage, you are only charged the interest on the amount used, and not the full amount approved in your application.

For example, if you have only drawn down $50,000 of a $500,000 loan, then you would only be charged interest on the $50,000 you used so far.

  1. Builders and constructors are only paid for work done. Because of a construction loan’s structure, there is an assurance that your team of builders and constructors are being paid for work that has been finished – and not on work that is yet to be completed. This keeps them motivated to continue working on your project.
  2. You need to present a few more documents than usual. In addition to the typical requirements of taking out a home loan, you will need to provide the following:
  • Building contract. This outlines the construction stages, progress payment schedule, timeline, and cost of building your home.
  • Building plan. It includes the layout and the size of the house you plan to build.
  • Quotations. This lays out the estimated cost of building additional features in your property like solar panel installation, pools, or landscaping. Lenders may look at these and assess if they may boost the value of your home.
  1. You can apply for a construction loan if you are an owner-builder. When you apply as an owner-builder, your lender may require you to submit specific documents. These may include copies of council certified approved plans, permits, licenses for construction works, outlines of full construction costs, timelines, invoices, and insurance policies.
  2. You can also apply if you have an external builder. If you have an external builder for your home construction, your application may start with submitting your property plans to your lender. A professional appraiser will then evaluate these plans and determine the expected value of the home when it’s completed.

Your lender will consider the expected value of the property and the total amount needed to pay the builder. Your builder will also have to submit a set of documents before your loan gets approved.

  1. You have to present an invoice at every stage. Your lender will make the payments to your building in every stage of construction. However, you must present an invoice before your lender issues payments.
  2. Features could be limited. Depending on the lender, you might not be able to access certain mortgage features with a construction loan. Redraw facility and the ability to make additional repayments could be unavailable, for instance. Talk to your lender to learn what features you could get for your construction loan.
  3. You may need a higher deposit. Some lenders may be reluctant to approve an owner-builder construction loan, usually capping the loan-to-value ratio at 60%. You should be prepared to pay a larger deposit if this is the case.
  4. You might have to pay for extra fees. Some construction loans have extra fees charged to cover additional costs. These costs may include the fees paid for having a valuer check your property after every stage is completed and administration fees. You have to consider all these costs in addition to the typical fees incurred for a home loan.

Also read: Five basic home loans every home buyers should know

It’s important to have a thorough plan as you will play an integral part during the building of your home. Make sure you consider some drawbacks and risks you may face during construction. Be organised and communicate all your concerns to your building team – one small miscomputation could cost you money.

If you want to explore your home loan options, talk to a professional such as a mortgage broker or do a home loan comparison yourself. He or she could give you financial guidance and direct you to the right loan products suited for your needs. Want to talk to a mortgage broker near you? Our find a mortgage page can help you out!