Construction Loans Explained
Thinking of building your own home, you will need to be familiar with construction loans.
Construction loans are not as straightforward as simple home loans. Additional decisions to be made, structure the loan, additional documentation and funding is released in an entirely different way.
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.
To avoid having to contribute your full deposit and being charged interest on the entire loan amount you can split the loan into land loan, construction loan
- Loan 1 land
- Loan 2 construction
At settlement of the land purchase, you pay lender’s mortgage insurance (LMI) on the land loan.
You start being charged interest and making repayments on the land loan.
The interest and repayments on the construction portion then start as each drawdown is processed.
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.
Generally, the amount you pay at the different stages of construction is as follows:
• The deposit: 5%
• The slab or base stage: 15%
• Frame stage: 20%
• Lockup stage: 20%
• Fit-out or fixing stage: 30%
• Practical completion stage: 10%
For the lender to make each progress payment the builder will provide an invoice for work completed. You will need to fill out a drawdown request form and send this with the invoice to your broker to submit it to your lender. The lender will confirm the work is complete then pay the builder.
Therefore changes to the contract and plans can trigger a reassessment of the loan. 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.
Problems can arise when other work on the site that isn’t completed by the builder that needs to be paid for, as some lenders only make the remaining funds of the mortgage available after the completion of construction.
Because some builders will include subcontractors as part of the main contract, that are paid by the builder as works are complete throughout the drawdown schedule, others will not do this. Again, this may make it necessary to pay from your own pocket.
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Published by MFAA