Understanding Construction Loans

Building a home can be a daunting task to take on, so you really want to know what you’re getting yourself into from the beginning. There’s a few pathways into this, so we’ll lay them out:

  • Vacant land and separate build contract
  • House and Lack Package
  • Knock-down-rebuild

Vacant Land & Build Contract

Vacant land can be purchased from a developer as part of a development like a new suburb, or you can purchase land that is within an established area. If it’s part of a new development, there may be a wait for the block’s title to be registered with the government. This can add months, or even years in some cases, to your timeline so you want to factor that in.

You can purchase vacant land on its own and then get a tender (quote) from your chosen builder. For owner occupiers, if you don’t have a build tender when you apply for the land loan, the bank will include your current rental expense. If you have a build tender, they will exclude your rental expense because there is evidence it will be non-recurring when you move into the new build. This can have a big impact on your borrowing capacity if you’re paying a high weekly rent. For First Home Buyers that want to be eligible for schemes in NSW, you’ll need to have the build tender when you apply for the land loan and you’ll need to enter into a contract to build within 12 months of settlement.

For investors, if you don’t have a build tender when you buy the land, the lender is unlikely to factor in future rental income which may impact your borrowing capacity. If you have the build tender, the lender can verify the estimated rental income that applies to that type and size of property and allow that to be used as eligible income.

If you have your build contract ready to go at the same time as your land, you can apply for the one loan and settle it in one go rather than land followed by build.

Construction of a building is usually broken up into 5 or 6 stages. Once each stage is completed the builder will invoice you for that work and you will advise your lender to make a ‘progress payment’ which is paid directly to the builder. You will need to confirm that each stage has been completed before authorising the progress payment to be made. The first progress payment will not be paid by your lender until you have paid all of the savings that you have committed to contributing. On the final stage, the bank will organiser a valuer to be sent to the site to confirm the construction is as expected before paying the final payment.

Progress payments mean that you are not paying interest on funds that haven’t been drawn down yet, saving you interest. Your loan repayments will gradually get bigger as each stage progresses and your loan is drawn down to its full limit. During this time, you may be able to pay Interest Only repayments to lessen the burden on you if you are also paying rent, or if you are building it as an investment and aren’t earning the rental income yet.

House & Land Package

If you purchase a house and land package, the land and the construction are tied into one package and managed by the builder or developer. Depending on the package and the timing, you may not have a choice of features and colours. These packages vary in their structure, but often you will make an initial deposit and the remainder isn’t due until the property is completed. Others will use the progress payment structure mentioned above. It is important to ask the agent or developer how it will be structured so that you can apply for the right kind of finance.


Finally, a knock-down-rebuild is, as the name suggests, where you knock down an existing dwelling to build another. This is usually done where the existing building would cost more to repair/renovate than reconstruct, or potentially the land could be better utilised with a different dwelling – for example a 2 bedroom shack is demolished to be replaced with a duplex.

If there is a mortgage on the property that is to be demolished, the lender needs to consent to the knock-down-rebuild as they have a legal right to the security. If you are purchasing a property with the intention of a knock-down-rebuild and are borrowing the construction funds, the existing property is treated the same as vacant land.

Important Note: The above scenarios are assuming a fixed price contract with a licenced builder. If you are planning on “Owner Builder” where you oversee the construction yourself, there is a limited number of lenders who will entertain this and strict rules around how you can proceed. Additionally, any contract that is not a “Fixed Price Build Contract”, such as a “Cost Plus Contract” will have different rules and you should discuss your intentions with your Broker to see how this will impact your finance solution.

Key points to remember:

·         Land loan and construction loan at same time for better borrowing capacity

·         All your savings contribution to be used first before lender progress payments start

·         Interest Only payments during construction may help ease burden

·         Progress payments aren’t released to builder until stage is confirmed as completed

·         Owner Builder or Cost Plus Contracts play by different rules, consult your Broker

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