What are construction loans?

What is a Construction Home Loan?

Home renovations in Australia have become even more popular in recent times. House prices are increasing and people are weighing up whether to buy an existing home or build a new one or if they already own an existing home whether to renovate or sell and buy a new home.

The stamp duty savings combined with the equity that can be created when building a new home can mean that the cost of building compared to buying a newly finished home is significantly less.

To meet the finance needs of people borrowing to construct their new home, banks and other lenders have developed specialist home loans for construction typically called construction loans.

Construction home loans come in different types. There are construction loans designed for self-employed people that do not yet have all their financial records such as tax returns in order to prove their income a capacity to repay the loan. These are typically call low documentation construction loans or low doc construction loans. Most construction loans require you to engage a licensed builder however, some lenders also have construction loans for people building their own homes. These are typically called owner builder loans. Owner builder loans are stricter than ordinary construction loans that have a licensed builder doing the construction work. This is because there is more risk that the owner builder will not be able to finish their project on time and budget, as banks and lenders have data that shows owner builders are less likely to finish on time and budget.

How Does a Construction Home Loan Work?

Construction loans are set up so that you only borrow enough money to cover the costs when they are incurred. That is once the builder finishes a stage in the construction they invoice the owner, the owner then receives the funds from the bank or lender. In this way the borrower only pays interest on funds that are used. It also means that the lender can make sure that what is borrowed matches the value of the construction. This is important for the lender as if anything goes wrong the lender will want to ensure that it can get its money back by selling the property. It can also benefit the borrower as the builder cannot charge them for work that has not been completed.

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