It is wonderful to design and build your home the way you always imagined it to be. But, it can also be long and expensive–that’s why, many people are unable to pay the construction cost in advance. Here, a normal mortgage may not meet your needs, and hence, construction loan comes into the picture.
However, most lenders are quite particular about construction loans as you are asking money for something that does not exist yet. Moreover, there is less certainty of the property attracting a good resale price after completion.
If anything goes wrong, like the builder doing a poor job or a depreciation in the property’s value, then it would be a bad investment for the bank. The property would not be just as worth as much as the amount lent.
A construction loan is meant for people building a new house from ground up instead of settling in a ready-to-move house. Hence, for a construction loan you first need to own a piece of land where the construction will commence within an agreed period. Before loan’s approval, you need to deposit a security amount (about 20% of the total construction amount) to the lender. However, you may find that most lenders are ready to lend up to 95% of the total amount but, you would still need the Lenders Mortgage Insurance.
While obtaining a construction loan, you should know that the value at which most lenders estimate the complete package is based on the value of the land as well as the cost of the building materials. For instance, if a land was purchased for $150,000, and fixed price building contract of $180,000, then the the total value of the loan would be $330,000.
Ask your builder for an estimate before signing the fixed price building contract for construction. There might be some variations later, but fixed price building contract will establish most of the construction costs and fixed price building contract will explain the 5 progress payments’ schedule, especially if the construction cost is under $500,000.
Mostly, the builder and lender follow the HIA (Housing Industry of Association) or MBA (Master Builders Australia) prescribed progress payment plan. So, it includes a clear outline of each stage of construction on the building contract along with the estimated time of completion.
It is standard for a borrower to pay the lender only the interest that is due on the amount drawn. The common period allowed for finishing construction is up to two years.
During the course of construction, your home will be inspected periodically for code compliance and other quality checks at critical points. The idea is to catch as many potential issues as possible before construction is finished. However, there may remain some issues that may not surface until you’ve lived in the home for a period of time.
Here are the five stages of home construction and process of inspection that determine the amount lended, considering the lender agrees to 5% of the amount as security deposit.
At this stage, the builder works with site cutting and initial plumbing. The work begins on a site that devoid of any gravel, debris or plantation. It is levelled as a guide for the foundation with holes and trenches dug up and footings being installed.
If the foundation is a slab-on-grade, then the footings are scooped out, formed and then concrete is poured into the holes and trenches. Concrete then needs some days to cure and construction halts for that period. After that, plumbing and waterproofing is taken care of.
The focus of first inspection is the slab and after its successful inspection, 10% of the construction money is given out.
The inspector will check whether the plumbing and workmanship are of acceptable for Australian standards. Your inspector will carefully evaluate any irregularities and inform you if they are of great significance.
Builders will put up the frame of the house which exhibits the progress in the partial brickwork, roof, trusses and windows.
15% of the total construction loan amount is turned over during this stage. The building inspector confirms whether the roof’s framing conforms to the most recent plans and specifications and checks the wall placement and dimensions of windows and doors for their specifications mentioned in the plan.
The Lockup stage of construction is named so because this is when the doors and windows become lockable. Construction sites attract thieves–which is why it is best not to install any appliances or fittings before installation of locks.
You should confirm that all the agreed lockup terms in the contract have been met before making any payments as this is the most significant percentage, 35%, of the entire process.
The examination at this point ensures that the general workmanship is appropriate. This includes proper installation of bricklaying/weatherboard, and the roof covering.
Additionally, the inspector may also look at services like plumbing, gas, and electrical fitting to gauge whether they are located in appropriate places and are installed according to building standards.
Here, the builder starts-off with installation of the plasterboards, part-installation of cupboards, and benches. All plumbing and electrical works are completed, tiles are integrated, and the gutters and downpipes are installed.
The fourth stage of construction is when the next 20% of the contract amount is paid off. Inspection involves checking all the rough framing, plumbing, electrical, and mechanical systems to see whether they comply with all the building codes in the area and are in good working condition.
By this stage, the builder starts giving finishing touches to everything present and installed in the house, and doing the final electrical and plumbing fit-offs, removal of final rubbish and cleaning of the house.
The last inspection is performed to ensure that the house has been completed to the same degree at which it was initially appraised before handing over the keys to the new owners. An amount equalling 15% of the total contract is paid at this stage.
The final inspection is also required to convert the construction loan into a permanent mortgage. A building-code official completes a final inspection and issues a certificate of occupancy. If any defects are found during this inspection, a follow-up inspection may be scheduled to ensure that they have been corrected.
The owners and the builder/ builder’s representative may also do a final walkthrough of the house to ensure that the owners are satisfied with the construction and final finishes.
You should know that during most builders try offering ‘Fixed Price’ contracts, in case the building costs go up. So once this is fixed, the cost of construction of your new home will not change.
There are some conditions and items that may not be a part of the Fixed Price Contract. So, ask the builder to clarify the definition of ‘Fixed Price’ or ‘Site Costs’. For instance, any work done outside the land boundaries, any additional items not included in the building contract, or additional council/estate requirements and so on.
If your contract consists the mention of ‘To Be Announced (TBA)’ or ‘Not Consolidated (NC)’, then ask for verification. These are mostly a builder’s way of saying that the price of your house might be fixed, but there might be things that can change the cost. These costs are usually not guaranteed.
That is why you should be wary of any differences added by the builder to the final costs. These can also involve changes in the footings/foundation price after soil testing has been conducted.
Your building contract will include an allocation to cover other things like an upgrade during the color selection process, tiles, roofing, bricks and much more. However, if you spend more than you intended, your costs will go up, which you will have to cover out of your pocket.
Though most lenders are quite understanding about this, they will expect that all the final variations have been received by the time your finance approval is underway. If there are any changes in pricing after this time then you need to inform the bank to account for the extra, or you’ll have to shell that amount from your own pocket.
If you feel that you would require more more funds for other home improvements such as landscaping, then you can also opt for re-evaluation by your lender upon completion.
In case you are worried that the builders need to be paid before the set phases are done, you can consider obtaining a very small line of credit as part of the loan.
Keep in mind that when valuing the security property with owner builders, the actual completed value of the home is rarely taken into account. The lender instead looks closely at the quotes provided to form the estimated cost of materials and labour required to complete the construction. This is used as a ‘to be erected’, or TBE, valuation amount instead.
Construction loans are suitable for making major renovations to your existing home or a property that you might have just bought. The advantage of this loan type is that you are able to pay construction costs as and when they fall due. Most banks will also allow you to make extra payments off your mortgage while your loan is still in the progress draws stage. But, always check whether your bank will allow this.
Building your own home can mean you get everything exactly the way you want it and with a construction loan you remain in control of the building process at every stage.