For many people, using a building loan to create the home of their dreams is preferable to buying an established property. The opportunity to choose the land and the style of home can be irresistible.
Engage a building loan mortgage expert to bring your plans to life.
The first step towards buying a new home is always to understand the finance side of the deal. Building loans, or Construction loans as they are known in the industry are very different to standard “purchase” home loans. They vary in many ways including the timing and repayments through to the way in which the loan is released.
Getting professional advice from a mortgage broker with expertise in land and building loans is a vital part of creating your plans. There are pitfalls and challenges with this form of lending and when combined with the complexities of the building project itself, mortgage advice is critical.
Buying a new home
There 4 main ways to buy a new home:
You can buy a brand new home that is already built. Many builders finish a project and then put it on the market for sale. This can be a great way to buy a brand new home if you don’t want the headaches of a construction project.
Off The Plan properties are another way to buy a brand new home that distances the buyer from the construction project as the location and design are usually pre-planned by the developer. Off the plan purchases can have advantages but these need to be weighed up with the risks which include:
The value of the property being less than the price you paid by the time it is completed.
Project delays are commonplace, and a buyer needs to have a lot of patience with these projects.
Complex contracts. We’ve seen off the plan contracts of over 200 pages! Getting detailed legal advice before signing these contracts is the only way you can go into an off the plan purchase with clear knowledge of the risks.
Finance risks – we call them ‘time risks’. You might qualify for the loan you need now but how will you be placed in 2 years time when the project is complete and you need the finance to settle? From changes in your own circumstances to shifts in lender policies and the broader property market, off the plan projects present many challenges.
You may want to be an owner-builder. This is where the homeowner takes responsibility for the construction project and manages it through to completion. There can be a lot of money to save with this approach, but lenders don’t like owner-builder loans at all and there a very few options for this type of finance. Owner builder projects invariably run over budget and lenders don’t like being involved with “moving target’ finance.
Finally, you can buy your own block of land and engage a builder to build the home you want. This is when Land & Building loans come into play and forms the basis for the following article on land and and building loans.
Buying the land
The first step towards building your own home is to get reliable mortgage advice so you can set out to buy a block of land. How much you can afford to spend on the land needs to be balanced with the proposed building cost to ensure the project is affordable and viable from a lenders perspective.
Land size, zoning and location can all have an impact on how much you can borrow. Lenders are quite particular with the properties they will accept as security and can impose Loan to Value (LVR) restrictions or simply not want to lend against a property at all. You must understand these factors before you buy.
It is standard practise for a buyer to contribute their equity (cash savings or other property equity) at the time of land purchase. If the buyer is also contributing funds to the construction stage, this money must also be paid before the lender will release funds from the loan.
Once the land purchase has settled, your land loan will be in place and the repayments will commence. Budgeting for a land and building project is essential as you will probably need to pay rent until your new home is ready.
The building project
Once your land has settled and your borrowing limits are understood, it is time to arrange for pre-approval of finance so you can start to investigate building companies, architects and designs for your new home. When you have decided on a plan forward, your builder will prepare a Fixed Price Builders Contract, Building Plans and list of Building Specifications. At the same time, an application will need to be lodged for Town Planning/Council Approval. Nothing can start without Council approval and many a project is delayed by Council processes.
These documents are also needed by the lender before they can order a valuation on the property and progress assessment towards Formal Approval of Finance. Most builders will prepare documentation that allows you to enter into the building contract on a Subject to Finance basis and this is the ultimate protection a borrower can have when it comes to the provision of finance. Again, legal advice is always recommended before signing an unconditional contract.
The Fixed Price Builders Contract establishes an important component of the finance timing. Lenders will release funds from your construction loan in accordance with the stages specified in the building contract and the conditions of the loan approval. These stages are typically:
Payment of the Deposit
Most builders require at least a 5% deposit before they will start construction. The deposit may need to be paid from your own cash, or, by the loan, depending on the finance approval conditions.
Stage 1: Base Stage
The base stage usually includes pouring of the slab, laying the foundation of the house, levelling the ground, installing plumbing, and waterproofing the foundation. Stage 1 usually represents 10% of the total building cost and is paid to the builder, by the lender when the stage is successfully completed. Some lenders will insist that their valuer physically inspects the project at each stage before the green light is given for the bank to pay the builder their 10%. Many lenders don’t insist on this but some do.
When the lender makes the first payment to the builder, the building loan commences, and monthly interest repayments begin. Interest will be charged daily and repayable monthly based on the balance owing to the bank. This method of repayment is helpful to the borrower as it frees up more cashflow to cover expenses such as rent while the home is being built. The loan balance increases as each stage is completed and the repayments also increase to cover the interest owing to the lender.
Stage 2: Frame Stage
This stage usually includes the builder working on some of the brickwork, constructing the trusses, roofing, and windows of your home and often represents another 15% of the total building contract price. Upon stage 2 completion, the construction loan will be sitting at 30% of the total approved amount.
Stage 3: Lock-up Stage
Time for the most significant chunk of work to be done. This stage is called “lock-up” as it includes all the works required to close up the building. These works include the construction of walls along with installation of the doors and windows. Stage 3 normally represents 35% of the total build contract price. Upon stage 3 completion, the construction loan will be sitting at 65% of the total approved amount. Now, the interest payments are really starting to kick in.
Stage 4: Fixing Stage
Time for the builder to install all the fixtures and fittings needed to complete the home — kitchen appliances and cabinetry, bathroom cabinets, doors, tiles, and all the internal plastering and walls will be constructed. Electrics and plumbing are usually completed at this stage which often represents another 20% of the total build contract price. Upon stage 4 completion, the construction loan will be sitting at 85% of the total approved amount.
Stage 5: Completion Stage
The finishing touches are now underway. Painting, installation of carpets and light fittings, garden landscaping work (if included), fencing and site clean-up come to conclusion. As the name implies, this stage covers all the finishing touches, including painting, installation of fences, polishing of walls and floors, and cleaning of the site. Stage 5 normally represents the final 15% of the total build contract price. Upon stage 5 completion, the construction loan will be sitting at 100% of the total approved amount.
When the project is complete it is time for you to do the final inspections to make sure that the property is built as expected. The lenders valuer will also want to see that the job is done to lender standards. Now is the time to identify any issues or problems with the building and the building contract will specify how much time you have for recourse on certain aspects of the project. Guarantees and warranties should also be understood to make sure any major structural problems can be addressed by the builder.
What happens to the Construction Loan now?
When the building loan is fully drawn it usually reverts to a standard Principal & Interest repayment loan for the remaining term of the loan. This can be a sensible time to discuss options with your broker to make sure the ongoing loan type will meet your needs and requirements. Can the land and building loans be merged into one loan? Could a fixed rate portion now be considered?
Building your own home can be one of the most exciting things you do in your life, but it can also be one of the most stressful. Hundreds of decisions need to be made and there are countless hours to be invested. To learn more about the process of building your own home we recommend this Australian Government website which contains a wealth of information and serves as an excellent ongoing resource for your project.
Our job as your mortgage broker is to ensure the financial side of the project is well thought out, feasible and gets delivered on time. One thing you don’t need is stress with the finance! Get the expert advice, engage trusted professionals and look forward to that special day when you get the keys to your new home.
This article contains general information only and cannot be relied upon in every situation. Building loans are complex and there are many variables. We recommend that our clients obtain appropriate legal and financial advice before entering into any binding contract.