How Do Construction Loans Work?

If you're buying land and building a new home, your finance works a little differently to buying an established property.

Rather than receiving the full loan amount at once, your finance is usually split between the land purchase and the construction of your home.

The good news is you don't need to understand every part of the process yourself. Your Start Smart mortgage broker will help coordinate your finance, explain each stage and deal with the lender requirements along the way.

Step 1: Your land settles

The first part of the loan is used to purchase and settle your block of land.

Once settlement is complete, you own the land and your repayments generally begin on the interest applicable to the amount that has been advanced for the land.

Your Start Smart mortgage broker will work with your lender and settlement team to help make sure everything is ready when your land is due to settle.

Step 2: Construction begins

Now, the builder can get to work on your home!

Your builder is not paid the full construction amount upfront.

Instead, the lender releases funds progressively as your home is built. These are called

progress payments.

They usually occur at stages such as:

• Deposit

• Base or slab

• Frame

• Enclosed or lock-up

• Fixing

• Practical completion

Your builder issues an invoice at each stage, and the lender releases the appropriate payment once their requirements have been met.

Your StartSmart mortgage broker will help guide you through this process, so you don't need to work out progress payments or lender requirements on your own.

What repayments do you make while the home is being built?

During construction, you generally only pay interest on the money that has actually been used.

This means your repayments start lower and gradually increase as more of the construction loan is released.

Let's look at an example

Assume you are purchasing:

Land: $300,000 Construction: $500,000 Total project: $800,000

You have a 5% deposit of $40,000, which is contributed upfront toward the land purchase.

This leaves a land loan of $260,000.

Assuming an interest rate of 6% p.a., the interest payable on the land loan would be approximately:

$300 per week

Once construction starts, your lender progressively releases the $500,000 construction funds as your home is built.

Construction Stage	Stage %	Progress Payment	Approx. Loan Balance	Approx. Interest per Week
Land settled			$260,000	$300.00
Deposit	5%	$25,000	$285,000	$328.85
Slab	15%	$75,000	$360,000	$415.38
Frame	20%	$100,000	$460,000	$530.77
Enclosed	25%	$125,000	$585,000	$628.85
Fixing	20%	$100,000	$685,000	$738.46
Practical Completion	15%	$75,000	$760,000	Move in – no more rent!

So even though your total loan will eventually reach $760,000, you are not paying interest on that full amount from day one.

The loan balance increases progressively as your builder completes each stage.

Your Start Smart mortgage broker will talk you through what to expect before construction begins and will be there throughout the build if you have questions about progress payments, loan balances or repayments.

This example assumes an interest rate of 6% p.a. and interest-only repayments during construction. Figures are approximate and are provided for illustrative purposes only. Managing your budget during construction

For many first home buyers, getting to the construction stage means you have already spent months saving hard for your deposit while also paying rent.

One of the best ways to prepare for construction is to keep that same saving habit going for as long as you can.

In the early stages of your build, your mortgage repayments are generally lower because only a smaller portion of the construction loan has been drawn. You may find that the combination of your rent and construction loan repayments is similar to what you were previously managing between rent and saving for your deposit.

As your home gets closer to completion, more of the construction loan has been drawn and your repayments increase. This is often the stage that can feel a little more challenging because you may still be paying rent at the same time.

A little planning beforehand can make a big difference.

If possible, try to save a little extra before construction begins and during the early stages of the build. Having a buffer behind you can help soften the impact of the higher repayments towards the end of construction.

It can also help to look ahead at some of your larger annual expenses. For example, if your budget allows, consider paying things like vehicle registration, insurance or other annual bills for 12 months before construction begins. Removing a few larger expenses from your budget during the build can give you a little more breathing room.

And most importantly, remember that the period where you are paying both rent and the higher end of your construction loan repayments is temporary.

It can feel like a lot while you're in it, but it isn't forever.

Before construction starts, your Start Smart mortgage broker can talk you through the expected repayment increases at each stage so you can plan ahead and know what to expect rather than being surprised as your build progresses.

How much deposit will you need?

Your lender looks at the total cost of your project, including both the land and construction.

Your required contribution ill depends on things such as:

• The land price

• Building contract price

• Property valuation

• Your available savings or equity

• The lender and loan structure

• Any government schemes or grants you may be eligible for

This is something we work out with you before you commit to your land and build, so you understand how much you can spend and how much cash you will need.

You don't need to try to calculate this yourself. Your Start Smart mortgage broker will work through the numbers with you and structure the finance around your individual circumstances.

What about unexpected costs?

One of the reasons we are careful about the builders we work with is that we want our clients to know what their new home is going to cost from the beginning.

Start Smart only works with builders who provide comprehensive building contracts designed to include everything required to complete your new home.

This helps reduce the risk of getting part-way through your build and discovering that important items weren't included in the original price.

Of course, if you decide to make changes or add upgrades after your contract has been finalised, there may be additional costs.

If you're considering a variation, speak with your Start Smart mortgage broker first. We can help you understand whether the change will affect your finance and make sure you know how any additional cost will be covered.

Why getting the finance right matters

Construction lending has a few more moving parts than buying an established home.

There are land settlements, building contracts, valuations, lender requirements and progress payments to coordinate.

But you don't need to manage all of that yourself.

When you purchase your land and build through Start Smart Property & Finance Specialists, our team helps bring the property, builder and finance sides of the transaction together.

Your mortgage broker will help you:

• Understand how much you can afford before choosing your property

• Structure your land and construction finance

• Find a lender suitable for your construction project

• Explain your deposit and repayment requirements

• Coordinate lender requirements

• Guide you through the progress payment process

• Help with finance questions throughout your build

Our aim is to make building your new home feel simple, coordinated and easy to understand.

You can concentrate on choosing your home and watching it come together.

We'll help look after the finance behind it.

Thinking about buying land and building?

You don't need to work everything out before you speak to us.

Start with a conversation.

We'll help you understand your borrowing capacity, budget and options, then guide you through the land, build and finance process from there.

Buy Smart · Live Well.

The information provided in this article is general information only and does not take into account your personal circumstances. Lending criteria, fees, interest rates and construction requirements vary between lenders and are subject to change. Finance is subject to lender approval. Building inclusions and costs are subject to the individual building contract, specifications and any variations requested by the client.