Building your dream home? Think about a construction loan.

How do you finance the initial purchase of a block of land, followed by the home building process?
Do you need a loan for the land and then another loan for the home you build?
What comes first, the chicken or the egg?

This dilemma is the very reason a construction loan was created. Basically a construction loan is a standard home loan that features a progressive draw-down facility where you receive the total loan amount in predetermined installments, based on your construction schedule.
For instance, you might want the first progressive draw-down of, say, $200,000 to purchase the land. When you are ready to build, you may want a second draw-down of $20,000 to lay the foundations, followed by further draw-downs to suit the building stages.
Interest is only charged on the total amount of finance drawn down at any given time during the term of the loan.

Nuts and bolts of a construction loan

Home-and-land packages have been a popular choice for many first home buyers, especially in the outer metropolitan areas where land is still affordable. The ability to customize your dream home makes it even more appealing to many Australians. Because the exercise is done in stages - paying a deposit or paying in full for the land, commissioning a builder who requires payments at certain stages such as laying a concrete slab, roofing the frame etc - lenders have tailored a home loan to suit.
A construction loan is similar to any other mortgage banks and brokers offer with the major difference being in the way the loan is used or drawn-down. Instead of making one full withdrawal from your lender to finance a property, a construction loan gives the borrower access to funds in small, lump sums at various intervals to suit building stages.
If you are in the fortunate position of being able to call on existing equity in a property to finance a building project, a revolving line-of-credit would likely be the first choice of finance. However, the majority of borrowers rely on a construction loan.

What makes a construction loan so special?

Financing a property development with a normal mortgage would be impossible for the simple reason that the lender does not have enough security on the property. Building on a block of land increases the value of the property and lenders then may be able to offer you more. During the construction stages, your lender may re-value the property to ensure they have enough security to cover their worst-case scenario: you default on your loan. Typically, building insurance is a requirement set by your lender for a construction loan.

Points to consider

As with any loan there are specific questions you need to check off with your lender.
There may be some costs involved when making a progressive draw-down. Normally, lenders offer a number of free draw-downs but you may be liable for extra cost if you exceed this limit.
Think about your own personal requirements and choose a loan to fit with that. There is a wide variance in the marketplace - at CANSTAR CANNEX we have seen some products offering an unlimited amount of draw-downs while others charge fees of up to $240 per draw-down.
Other fees to be aware of are valuation fees. Over 61% of loans tracked by RateCity indicate that the lender will require valuations on the property for each of the draw-downs. You may be liable for extra costs, as the valuation fee is normally passed on by the lender to the borrower.
When building a house the length of construction period can become an issue. It is important to check with your lender how they deal with the unexpected - such as rain delay in construction. Some lenders will still allow you to continue drawing-down funds but others will cap the period of time allowed before you must take the full amount of the loan.

Where to start shopping?

It's not difficult to find a construction loan, as it is very similar to a normal mortgage. Most lenders have this construction feature with their variable rate loan. In fact, RateCity statistics tell us over 71% of variable rate loans are available as construction loans.
For your convenience we have listed below some of the mortgage product which can be used as construction loans. At RateCity you can compare hundreds of home loans and see the ones that offer a construction facility.

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