Compare construction loan rates from 5.68%

A construction loan is designed for borrowers building a home, rather than buying an existing property and helps to keep costs down during the building process.

What is a construction home loan?

Unlike a regular home loan, a construction or building loan covers expenses incurred as the building process takes shape. They're typically drawn down in stages and incur interest only repayments. This helps keep repayments low while a home is being built.

At the end of a build process, construction loans generally transform into a normal mortgage product.

How do construction home loans work?

Construction loans operate through a process known as 'progressive drawdown.' The loan amount is progressively disbursed as different stages of the building works are completed.

As the process continues, you'll only pay interest on the funds used during the build and you won't need to repay the principal until the construction is complete.

So, if your total building cost are expected to be $400,000 but you've only needed to hand over $100,000 of borrowed funds so far, you'll only be charged interest on that $100,000 and not on the $400,000 total.

That helps to keep repayments low in the period you can't live in the property and will likely still have the outlay of rent.

Your lender will make payments to your builder at every stage of construction. As each phase is completed, your lender will require you to present an invoice from your builder to issue payment.

Your lender will likely be very involved in the process. Typically, they will send someone to inspect the progress of construction before releasing the next payment to your builder.

How to compare construction home loans

Comparing construction loans is simple. Browse some of the market's most competitive deals in the table above, and filter the options to find a mortgage that suits your situation. Here are some of the key aspects to look out for:

Interest rate

Interest rates are typically higher on construction loans than on traditional home loans. Interest also works slightly differently on construction loans, as lenders only charge interest on the funds paid to a builder at a given time (not the entire build cost) and borrowers generally only need to pay interest until the works are complete.

Comparison rate

Like with any home loan product, borrowers should also pay attention to the comparison rate. This figure factors in interest costs, as well as additional fees and built-in rate changes. It's calculated considering a $150,000 home loan over 25-years.

Eligibility

Building contracts come in fixed cost or cost plus options. As the name suggests, a fixed cost contract sets a 'fixed' price for the works being done. Under a cost plus contract, costs can easily increase if the scope of work changes. Many lenders only offer construction loans to owners with fixed cost contracts.

Fees

Home loans often come with fees and borrowers should always keep an eye out for them. When it comes to construction loans, they might want to consider additional like progressive drawing fees, valuation, and inspection fees too.

How popular are construction home loans?

Construction loans are a popular way to finance a home build as they allow the flexibility and financial leeway many homebuilders need during the construction stage.

While there use appears to have waned in recent years, that’s likely a reflection on the broader housing and economic environment. As the table below shows, the number of owner-occupiers taking out construction loans dropped amid Reserve Bank of Australia (RBA) rate hikes and broadly rising house prices in early 2023.

The rise in the number of owner-occupiers taking out loans to fund construction in 2020 and 2021 may relate to the introduction of the $25,000 HomeBuilder grant in June 2020, it’s reduction to $15,000 in January 2021, and its repeal in March 2021.

What documentation do you need to apply for a construction loan?

When applying for a construction loan, lenders usually require more than what you'd need to hand over during a typical home loan application, as they need to assess both your financial position and the building project itself. Some key documents include:

• Contract of sale
  Before you break ground on your building project, you'll need to own that ground. Your lender will want the contract of sale related to your land purchase or proof of ownership.

• Council approved plans
  Your lender will want evidence that your proposed project has received the necessary council approvals to avoid financing something that could later be rejected.

• Building contract
  This must be signed and dated. It should detail the building plans, total cost, and a progress payment schedule that aligns with how the lender will release funds in stages.

• Builder’s credentials and insurance details
  Typically you'll need to provide proof of Builders' Risk Insurance and your builder's Public Liability Insurance. Some lenders also ask for your builder's license details.

Why are interest rates higher on construction loans?

Construction loans tend to have higher interest rates than traditional principal & interest (P&I) home loans. This is largely due to three factors:

1. Home loans with interest only repayments typically represent higher risk for a lender
   A person making interest only repayments isn't paying off their debt, after all.

2. Homes under construction also present more risk
   Much of the asset used as security on the loan (the property) doesn't exist yet, and complications could arise as it's built.

3. It can hard to determine your final loan-to-value ratio (LVR)
   Complications or cost blowouts could reduce the equilibrium between your deposit and the value of the home, which can increase a lenders' risk.

Various fees associated with construction loans may also be higher than those of traditional mortgages. The valuation fee, for example, might be higher as the valuer must assess the home's worth at each stage of construction.

Pros and cons of construction loans

There are a few things to weigh up when it comes to building a home versus buying an existing one, not least of which are the considerations that come with taking out a construction loan.

Pros of construction home loans

• Smaller repayments
  Lenders dish out money for each step of construction, meaning you only pay interest on the amount used at a given point in time. Additionally, construction home loan repayments are generally interest only during the construction process.

• Protection at each stage
  Construction loans are usually dished out in stages, with the lender and valuer assessing work at each stage. More eyes watching can provide some protection from dodgy work.

• Less stamp duty and more grants
  Stamp duty payable depends on a property's purchase price, and since vacant land is typically cheaper than an existing house, a home builder will likely pay less stamp duty. On top of that, many state governments offer stamp duty concessions and grants to those building new homes.

Cons of construction loans

• Challenges of building
  There're lots of unknowns associated with building a home. Poor weather, dodgy tradies, and material shortages can draw out the process and add to costs and the final product might not be what you envisioned when you started.

• Higher rates
  Interest rates are typically higher on construction loans. If costs blow out, that can also result in a higher LVR than expected.

• More overall interest paid
  If you make interest only repayments during the construction phase and your home loan repayments later roll into principal and interest, you'll ultimately pay more interest than if you made principal & interest repayments from the get-go.

What happens once construction is over?

Construction loans usually only demand interest only repayments while the build process is underway, meaning repayments are lower during this phase.

Once construction ends, the home loan might be transformed into a regular mortgage with principal and interest payments. This means you will start to pay down the principal of the loan, which could see your regular repayments jump significantly.