Land and Construction Finance 101
For some, home construction can be the best value pathway to home ownership, whilst for others it’s the means to building their dream home.
If you’re looking to build a new home or in some cases undertake a significant renovation, there are loan products available to you to fund both the purchase of land and construction of your new home. All of the majors and many of the quality tier two lenders have high quality construction finance products.
The two underlying pillars of home lending remain in that the bank relies on their valuation of the property to ensure they are adequately secured, and also assess your income to get comfort around affordability.
If you’re buying land first to later build on, it’s important to seek pre-approval for the construction finance simultaneously so you know you’re good for it. Where you’re buying a land and house package seeking finance will naturally be done at the same time.
Most commonly your loans will be structured as a land loan, and a building loan at least for the duration of the build after which they can be merged.
The banks rely on an ‘as if complete’ valuation of the property as their ultimate security value, which in most cases is the value of the land plus the cost to build the residence. For this reason banks will only lend against a ‘fixed price building contract’ (opposed to a ‘cost plus’ build where the final price isn’t stated and can vary).
The banks will then pay the builder progress payments matched to the payment schedule in the building contract, after they have verified at each stage that those works are complete and have thereby added said amount of value to the property. At each stage the borrower needs to send a payment progress request with the builder's invoice, or compiled invoices where subcontractors are being paid directly.
The bank will only pay 80% of each progress payment given they’re only funding 80% of the build, so you will need to fund 20% of each progress payment yourself. Many banks will require your 20% contribution for the entire build upfront whilst others will take 20% at each progress payment.
Some other important things to consider when looking at construction finance;
Generally, the construction loan and possibly the land loan will be interest only during the build phase, and should be so at P&I rates
The bank will require full fixed price contract and building plans prior to formal approval, though will provide a pre-approval based on affordability prior to this
Be careful that you’re across all possible costs and inclusions as banks won’t pay for additional costs not in the building contract, or any amendments
You can use equity in existing property to fund your 20% contribution
If you have any questions or wish to discuss your construction finance options please get in touch.
