It is not wise to obtain a construction loan without understanding it because lack of knowledge can create financial problems for you. Here is a simple guide you can use to understand how a construction loan works.
Construction loans are becoming more popular than ever and many people are choosing to build their new home. So, if you are looking to build your dream home particularly with the continued financial assistance provided by the government with the First Home Owners Grant (FHOG) scheme, it is the best time to do it. But, before you jump on the band wagon and obtain a construction loan, it is important that you understand the loan package in detail.
What is a Construction loan?
It is a short-term, interim loan for financing the cost of constructing your new dream home. Lenders/credit providers will secure a mortgage over the real estate property you are financing and they will make periodic payments to your builder at periodic intervals as the work progresses.
How is a Construction Loan Funded?
Lenders/credit providers have different credit policies and requirements that they adopt when processing a loan application. However, most are similar. Here is a list of how lenders/credit providers fund construction loans:
>> Lenders/credit providers will fund the loan amount required by you to cover the cost of purchasing a vacant land and for the building construction costs
>> Before construction starts and if you have already borrowed to purchase vacant land on which you are building your new dream home, the first loan disbursement made by the lender/credit provider will go towards paying off the vacant land
>> Lenders/credit providers will break down the loan amount into “progress payment drawdown” amounts, which are made to the builder at the completion of each construction stage
How is a Construction Loan Structured?
Construction loan, whilst it is similar to a traditional mortgage, has some key differences. Here is a list of the key features of a construction loan:
>> It is typically a short-term solution with a maximum of one year
>> The borrowers will be expected to pay Interest Only payments during the construction period
>> Interest is only calculated against the portion of the loan amount that has been drawn down
>> Construction of your new home must commence within 12 months of loan settlement
>> Construction of your new home must be completed within 12 months of the first progress drawdown payment
When are Progress Payments Drawn Down?
Lenders/credit providers will arrange to prepare valuations before progress payments are made to the builder and at the completion of each of the following construction stages:
>> For the purchase of the vacant land
>> After the laying of the flooring
>> After the installation of the roof (including the frames)
>> At lock-up stage, and
>> At the completion stage
What Happens with the Construction Loan at the Completion of the Building Project?
Upon completion of the building project, your loan will roll over into a standard Principal and Interest home loan.
What Additional Documents are required for Processing a Construction Loan?
Lenders/credit providers will need to see copies of the following documents, before issuing unconditional approval:
>> Fixed Price Building Contract
>> Council Approved Plans and Specifications
So, don’t forget to provide these additional documents along with your financial documents to the lender. If you keep all the paperwork ready, the lender will be able to provide you quick approval on your loan application.