Compare construction loans offered in Australia
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.
What is the Maximum LVR?
Want to know more about the Loan to Value Ratio?
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).
Rachel Wastell is an award-winning writer with a knack for translating complicated subjects. She is a strong environmental advocate, and is as passionate about the planet as she is about finance and open education. Writing professionally for almost ten years, Rachel's work has been published across the Australian media landscape including the Australian Financial Review and The Guardian, and she regularly contributes to Business Insider and Lifehacker.
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.
If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.
When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.
There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.
The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.
The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.
In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.
Bad credit home loans can be dangerous if the borrower signs up for a loan they’ll struggle to repay. This might occur if the borrower takes out a mortgage at the limit of their financial capacity, especially if they have some combination of a low income, an insecure job and poor savings habits.
Bad credit home loans can also be dangerous if the borrower buys a home in a stagnant or falling market – because if the home has to be sold, they might be left with ‘negative equity’ (where the home is worth less than the mortgage).
That said, bad credit home loans can work out well if the borrower is able to repay the mortgage – for example, if they borrow conservatively, have a decent income, a secure job and good savings habits. Another good sign is if the borrower buys a property in a market that is likely to rise over the long term.
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.
If you want to get a home loan with bad credit, you need to convince a lender that your problems are behind you and that you will, indeed, be able to repay a mortgage.
One step you might want to take is to visit a mortgage broker who specialises in bad credit home loans (also known as ‘non-conforming home loans’ or ‘sub-prime home loans’). An experienced broker will know which lenders to approach, and how to plead your case with each of them.
Two points to bear in mind are:
- Many home loan lenders don’t provide bad credit mortgages
- Each lender has its own policies, and therefore favours different things
If you’d prefer to directly approach the lender yourself, you’re more likely to find success with smaller non-bank lenders that specialise in bad credit home loans (as opposed to bigger banks that prefer ‘vanilla’ mortgages). That’s because these smaller lenders are more likely to treat you as a unique individual rather than judge you according to a one-size-fits-all policy.
Lenders try to minimise their risk, so if you want to get a home loan with bad credit, you need to do everything you can to convince lenders that you’re safer than your credit history might suggest. If possible, provide paperwork that shows:
- You have a secure job
- You have a steady income
- You’ve been reducing your debts
- You’ve been increasing your savings
A bad credit home loan is a mortgage for people with a low credit score. Lenders regard bad credit borrowers as riskier than ‘vanilla’ borrowers, so they tend to charge higher interest rates for bad credit home loans.
If you want a bad credit home loan, you’re more likely to get approved by a small non-bank lender than by a big four bank or another mainstream lender.
No. Temporary discounts to home loan interest rates will expire after a limited time, so they aren’t valid for comparing home loans as part of the Rate Guarantee.
However, if your home loan has been discounted from the lender’s standard rate on a permanent basis, you can check if we can find an even lower rate that could apply to you.
Most comparison sites give you information about rates, fees and features, but expect you’ll pay more with a low advertised rate and $400 ongoing fee or a slightly higher rate and no ongoing fee. The answer is different for each borrower and depends on a number of variables, in particular how big your loan is. Comparisons are either done based on just today or projected over a full 25 or 30 year loan. That’s not how people borrow these days. While you may take a 30 year loan, most borrowers will either upgrade their house or switch their home loan within the first five years.
You’re also expected to know exactly which features you want. This is fine for the experienced borrower, but most people know some flexibility is a good thing, but don’t know exactly which features offer more flexibility than others.
What is the flexibility score?
Today’s home loans often try to lure borrowers with a range of flexible features, including offset accounts, redraw facilities, repayment frequency options, repayment holidays, split loan options and portability. Real Time Ratings™ weights each of these features based on popularity and gives loans a ‘flexibility score’ based on how much they cater to borrowers’ needs over time. The aim is to give a higher score to loans which give borrowers more features and options.
They’re not always timely
In today’s competitive home loan market, lenders are releasing new offers almost daily. These offers are often some of the most attractive deals in the market, but won’t get rated by traditional ratings systems for up to a year.
The assumptions are out of date
The comparison rate is based on a loan size of $150,000 and a loan term of 25 years. However, the typical loan size is much higher than that. Million dollar loans are becoming increasingly common, especially if you live in metropolitan parts of Australia, like Sydney and Melbourne. It’s also uncommon for borrowers to hold a loan for 25 years. The typical shelf life for a home loan is a few years.
The other problem is because it’s a percentage, the difference between 3.9 or 3.7 per cent on a $500,000 doesn’t sound like much, but equals around $683 a year. Real Time Ratings™ not only looks at the difference in the monthly repayments, but it will work out the actual cost difference once fees are taken into consideration.
A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.
A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.
Split rates home loans
A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.