Compare construction loans offered in Australia
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When you come to buy a property, you may expect to buy one that’s been lived in previously, or to buy one off the plan from a real estate developer. However, many people dream of building their own home instead.
If you're imaginative and prepared to take a few risks, you could build your own home with the help of a construction loan.
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What is a construction loan?
Simply put, a construction loan is borrowing money to build a home or investment property. Construction loans can sometimes also be used to pay for major renovations to existing properties.
Unless you already own the plot of land, your loan will need to cover its purchase price, plus the estimated cost of construction.
Just like a typical mortgage, your lender will want to be confident that the value of the property will be enough to secure the loan, based on its Loan to Value Ratio or LVR. Before your application can be approved, the lender will estimate what the value of the property will be once construction is complete, and use this to work out the mortgage’s LVR.
A construction loan will often give you a short loan term – generally around a year – to complete the build.
When the build is finished, you’ll switch to a more typical mortgage, sometimes called the “end loan”, to pay off the remaining construction costs and value of the land. You may also have the option to refinance your mortgage at the end of the construction period.
How are construction loans different from typical mortgages?
In a standard home loan, you’ll receive the money you need to buy a house and land at the start of the loan term as one lump sum. You’ll then spend the remaining loan term paying back the money you borrowed (the principal) plus interest.
In a construction loan, the money you borrow is typically drawn down in stages as the build proceeds. So instead of receiving the money as one lump sum, you’ll draw down just what you need to lay the foundation, then to build the frame, and so on until the house is built.
Construction loans are often interest-only loans while the house is being built. Plus, interest will only be charged on the money you’ve drawn down so far, and not on the total principal. This can help to minimise your payments until construction is complete, whereupon the loan will either revert to a principal and interest loan, or you’ll need to refinance.
How does a construction loan compare to other mortgage offers?
Construction loan interest rates are likely to be higher than those of a typical mortgage. This is because the lender doesn't have a tangible asset to secure the loan; just something that’s expected to be constructed. It's hard for a lender to value this, as property prices in the neighbourhood could fall, or the builder could do a bad job.
Banks and other financial institutions may be wary of providing this type of loan, so it’s important that everyone involved is confident that the project will succeed.
What do you need for a construction loan?
- A budget: Your lender will need to know you can not only afford the repayments during construction, but also when you revert or refinance the loan once the house is built.
- A construction plan: Before they will approve your construction loan, your lender will want the builder’s qualifications, detailed specifications for the building, including what materials will be used, and a timescale.
- A deposit: You may only need a smaller deposit to start construction (sometimes as little as 5% of the projected property value), however once the project is complete and you revert to a more typical mortgage, you may need to make up a deposit of 20% or more to avoid being charged Lenders Mortgage Insurance (LMI).
- A good credit rating: Your history of borrowing and repaying money may be a factor when the lender decides whether or not to approve your loan application.
What are the risks of construction loans?
Construction projects can fall behind schedule, sometimes due to poor weather conditions, sometimes due to a builder not adhering to the project timetable. Delays can cost you money, so consider tying up everything contractually as tightly as you can, including penalty clauses for delays.
Payment stages in a construction loan:
- Slab: This amount is for building the foundation of your home, including the base, plumbing and waterproofing. This can be around 10 per cent of the total amount.
- Frame: This phase is where your builder will focus on constructing the ‘frame’ of your home including the windows, roofing and some brickwork. This can be around 15 per cent of the total amount.
- Lock up: This is usually around 35 per cent of the loan and covers the elements that are needed to ‘lock up’ your home. This can include external walls, doors and insulation.
- Fixing: Shelving, kitchen, bathroom cabinets, tiles, cladding and all other internal fixtures and fixings are included in this stage, and can make up around 20 per cent of the contract.
- Completion: As the name suggests, this is payment stages covers the completion of the building contract. Around 15 per cent of your loan will cover this, and includes all final installation pieces, including building property fences, cleaning, painting etc.
What are owner-builder mortgages?
An owner-builder mortgage works a lot like a construction loan, except rather than hiring a builder to complete the project, you handle it yourself as a DIY project.
Owner-builder loans are more likely to have stricter eligibility criteria, such as requiring larger deposits of 40% or more, or charging higher interest rates and fees. This is because most banks consider owner-builder loans riskier than other construction loans, as they can’t be as confident that you’ll be able to successfully complete the project to a professional standard (unless you are also a qualified and licensed builder).
Senior Financial Writer
Mark Bristow is a senior financial writer for RateCity and an experienced analyst, researcher, and producer. Working for over ten years, Mark previously wrote and researched commercial real estate at CoreLogic, and has seen articles published at Lifehacker and Business Insider, among others. Most recently, Mark has joined RateCity working across finance as a whole. Whatever the topic, Mark’s goal is always to provide simple solutions to complex problems.
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Frequently asked questions
What is a construction loan?
A construction loan is loan taken out for the purpose of building or substantially renovating a residential property. Under this type of loan, the funds are released in stages when certain milestones in the construction process are reached. Once the building is complete, the loan will revert to a standard principal and interest mortgage.
What is a draw down?
The transfer of money from a lending institution to a borrower. In a typical home loan, the funds are drawn down all at once in order to buy the property. In a construction loan, the money is drawn down in several stages to pay the builders as they progress through each phase of the project. In a line of credit loan, you can draw down money up to a limit based on your loan’s available equity.
What is a building in course of erection loan?
Also known as a construction home loan, a building in course of erection (BICOE) loan loan allows you to draw down funds as a building project advances in order to pay the builders. This option is available on selected variable rate loans.
What is a loan-to-value ratio (LVR)?
A loan-to-value ratio (otherwise known as a Loan to Valuation Ratio or LVR), is a calculation lenders make to work out the value of your loan versus the value of your property, expressed as a percentage. Lenders use this calculation to help assess your suitability for a home loan, and whether you need to pay lender’s mortgage insurance (LMI). As a general rule, most banks will require you to pay LMI if your loan-to-value ratio is 80 per cent or more. LVR is worked out by dividing the loan amount by the value of the property. If you are looking for a quick ball-park estimate of LVR, the size of your deposit is a good indicator as it is directly proportionate to your LVR. For instance, a loan with an LVR of 80 per cent requires a deposit of 20 per cent, while a 90 per cent LVR requires 10 per cent down payment.
LOAN AMOUNT / PROPERTY VALUE = LVR%
While this all sounds simple enough, it is worth doing a more accurate calculation of LVR before you commit to buying a place as there are some traps to be aware of. Firstly, the ‘loan amount’ is the price you paid for the property plus additional costs such as stamp duty and legal fees, minus your deposit amount. Secondly, the ‘property value’ is determined by your lender’s valuation of the property, not the price you paid for it, and sometimes these can differ so where possible, try and get your bank to evaluate the property before you put in an offer.
Does each product always have the same rating?
No, the rating you see depends on a number of factors and can change as you tell us more about your loan profile and preferences. The reasons you may see a different rating:
- Lenders have made changes. Our ratings show the relative competitiveness of all the products listed at a given time. As the listing change, so do the ratings.
- You have updated you profile. If you increase your loan amount, the impact of different rates and fees will change which loans are the lowest cost for you.
- You adjust your preferences. The more you search for flexible loan features, the more importance we assign to the Flexibility Score. You can also adjust your Flexibility Weighting yourself, which will recalculate the ratings with preference given to more flexible loans.
How much information is required to get a rating?
Mortgage Calculator, Repayment Type
Will you pay off the amount you borrowed + interest or just the interest for a period?
The amount you currently owe your mortgage lender. If you are not sure, enter your best estimate.
Select a number of years to see how much money you can save with different home loans over time.
e.g. To see how much you could save in two years by switching mortgages, set the slider to 2.
What factors does Real Time Ratings consider?
Real Time RatingsTM uses a range of information to provide personalised results:
- Your loan amount
- Your borrowing status (whether you are an owner-occupier or an investor)
- Your loan-to-value ratio (LVR)
- Your personal preferences (such as whether you want an offset account or to be able to make extra repayments)
- Product information (such as a loan’s interest rate, fees and LVR requirements)
- Market changes (such as when new loans come on to the market)
What is appraised value?
An estimation of a property’s value before beginning the mortgage approval process. An appraiser (or valuer) is an expert who estimates the value of a property. The lender generally selects the appraiser or valuer before sanctioning the loan.
Who offers 40 year mortgages?
Home loans spanning 40 years are offered by select lenders, though the loan period is much longer than a standard 30-year home loan. You're more likely to find a maximum of 35 years, such as is the case with Teacher’s Mutual Bank.
Even though these lengthier loans 35 to 40 year loans do exist on the market, they are not overwhelmingly popular, as the extra interest you pay compared to a 30-year loan can be over $100,000 or more.
How can I get a home loan with no deposit?
Following the Global Financial Crisis, no-deposit loans, as they once used to be known, have largely been removed from the market. Now, if you wish to enter the market with no deposit, you will require a property of your own to secure a loan against or the assistance of a guarantor.
Why should you trust Real Time Ratings?
Real Time Ratings™ was conceived by a team of data experts who have been analysing trends and behaviour in the home loan market for more than a decade. It was designed purely to meet the evolving needs of home loan customers who wish to merge low cost with flexible features quickly. We believe it fills a glaring gap in the market by frequently re-rating loan products based on the changes lenders make daily.
Real Time Ratings™ is a new idea and will change over time to match the frequently-evolving demands of the market. Some things won’t change though – it will always rate all relevent products in our database and will not be influenced by advertising.
If you have any feedback about Real Time Ratings™, please get in touch.
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These are the loans that may be suitable, based on your pre-selected criteria.
Why is it important to get the most up-to-date information?
The mortgage market changes constantly. Every week, new products get launched and existing products get tweaked. Yet many ratings and awards systems rank products annually or biannually.
We update our product data as soon as possible when lenders make changes, so if a bank hikes its interest rates or changes its product, the system will quickly re-evaluate it.
Nobody wants to read a weather forecast that is six months old, and the same is true for home loan comparisons.
What happens to your mortgage when you die?
There is no hard and fast answer to what will happen to your mortgage when you die as it is largely dependent on what you have set out in your mortgage agreement, your will (if you have one), other assets you may have and if you have insurance. If you have co-signed the mortgage with another person that person will become responsible for the remaining debt when you die.
If the mortgage is in your name only the house will be sold by the bank to cover the remaining debt and your nominated air will receive the remaining sum if there is a difference. If there is a turn in the market and the sale of your house won’t cover the remaining debt the case may go to court and the difference may have to be covered by the sale of other assets.
If you have a life insurance policy your family may be able to use some of the lump sum payment from this to pay down the remaining mortgage debt. Alternatively, your lender may provide some form of mortgage protection that could assist your family in making repayments following your passing.
Can I take a personal loan after a home loan?
Are you struggling to pay the deposit for your dream home? A personal loan can help you pay the deposit. The question that may arise in your mind is can I take a home loan after a personal loan, or can you take a personal loan at the same time as a home loan, as it is. The answer is that, yes, provided you can meet the general eligibility criteria for both a personal loan and a home loan, your application should be approved. Those eligibility criteria may include:
- Higher-income to show repayment capability for both the loans
- Clear credit history with no delays in bill payments or defaults on debts
- Zero or minimal current outstanding debt
- Some amount of savings
- Proven rent history will be positively perceived by the lenders
A personal loan after or during a home loan may impact serviceability, however, as the numbers can seriously add up. Every loan you avail of increases your monthly installments and the amount you use to repay the personal loan will be considered to lower the money available for the repayment of your home loan.
As to whether you can get a personal loan after your home loan, the answer is a very likely "yes", though it does come with a caveat: as long as you can show sufficient income to repay both the loans on time, you should be able to get that personal loan approved. A personal loan can also help to improve your credit score showing financial discipline and responsibility, which may benefit you with more favorable terms for your home loan.