Construction loan tips and tricks
Building a home is a complex process that involves multiple parties including builders, contractors, lenders, solicitors, accountants, quantity surveyors and the council. With so many people involved in the process, there is always the possibility that some experts will not understand each others field and things may go wrong. It can also be exceedingly complicated to obtain finance.
As a result construction loans are often set-up with many errors. The loan amount may be incorrect or it may be delayed, due to constant amendments.We have created this guide to help you ensure that you don’t have these same frustrations with your construction mortgage.
Your expectations are the key
Each lender processes a loan in a particular manner. With a conventional loan, it is often easy to have the loan submitted and approved in a timely manner. For a construction loan this system is often poorly designed and run by inexperienced staff within the banks. Loan documents are commonly lost and credit officers often lack communication skills. This can lead to misunderstandings and delays.
Our job as your mortgage broker is to fix these issues as they arise, and where possible, prevent them from occurring in the first place. No matter which lender you apply with, you will need to have some patience
How does the construction process work?
When you apply for a loan, the lender will need a copy of the building contract/tender and the plans. They will ask their valuer to estimate the on completion value of the property and will assess your loan on the lesser of the land price plus cost of construction or the on completion value.
Once your loan has been approved, the lender will issue a loan offer for you to sign and return, just like with any other home loan.When your builder is ready to begin receiving payments from the bank he will need to provide additional documents, such as the final council approved plans, his insurance & drawdown schedule.
How do you request that the bank pay your builder directly?
The builder will send you an invoice. You will then complete and sign a drawdown request form (available from your lender). Send the draw-down request form and the invoice to the construction department of your lender. The lender may require a valuation to confirm the work that has been completed so far. The funds will be advanced to your builder generally within five working days. Repeat this process for each progress payment required by the builder.
Changes to the building contract
Did you know that if you make an amendment with the builder and the contract price rises by just $100, the lender may need to reassess the loan all over again?
So how can you avoid changes causing a problem with your home loan?
Make sure that the building contract you provide the lender with is the final complete contract. If you make any small changes then try to pay for them from your own funds, or have the builder reimburse you for any discounts after construction is complete. For any large changes, you will need to notify the bank and then allow up to one month for the bank to reassess your loan. “Keep it simple” works very well with the banks! If you keep making changes then expect to have significant delays.
Other minor quotations for labour & materials
It is quite common for people to hire contractors to complete other work such as landscaping, utility connections, swimming pools or site works. Try and get all of these minor quotes included in the building contract and then have the builder pay for them.
This may not work for the builder, so discuss this with us and your builder before deciding on the best way to go.
Sometimes the banks will only release funds for other quotes on completion of construction. Be careful because you may have agreed to pay the contractor up front
One loan or two?
If you are buying the land, you may want to consider splitting the loan into a “land loan” and “construction loan”, which means that they will be advanced at different times. If this is not done then you will need to put all of your required funds in at the time the land settles.
Any LMI will be charged at land settlement.
We will discuss this with the lender to confirm their process and find out when you will be required to contribute your deposit.
How big a deposit do I need?
Most people go over budget – so risk management is key. We recommend that you keep saving during the construction process and try to avoid any large expenses until construction is complete. As a general rule, we try to ensure that you get approval for a slightly higher loan amount. This is to ensure that there are plenty of funds available. There is nothing worse than running out of funds when your house is almost complete!
If you are borrowing 100% of the cost of land & construction as with a family pledge home loan (guarantor loan), then you will still need some funds on standby to allow the builder to create the building contract & apply for council approval. This is because the lender cannot release funds outside of the specified construction drawdowns.
Additional work completed by contractors
In some cases part of the work is not being completed by your builder. Some common examples are:
- Swimming pool
- Power pole / power connection
- Site clearing
- Shed, dam or other hobby farm improvements
If you can provide a formal written quote for this work then we can often get the bank to extend the loan for these costs.
It really depends on the nature of the work and the lender that we are working with as to whether this will be possible or not. The key is to give us this information at the beginning of the process. If you tell us about the additional work later on then we cannot get the lender to finance it. Be careful as some lenders will only release money for the additional work once the main house is completed. This may not suit your construction schedule and so in some cases we need to change to another lender.
Are you paying cash?
If your builder is being paid cash for their work then no lender can approve a construction loan for you. They can only approve a loan based on the current value of your property. We recommend that you always sign a formal contract with your builder, ensure they have the correct insurances in place and follow all relevant state and federal legislation.
First Home Owners Grant
The First Home Owners Grant (FHOG) is paid to the lender by the government when the first drawdown is made to the builder. This means that many people who are borrowing a high percentage of the property value, may have enough funds to complete the project, but may not have enough funds to settle on the purchase of the land. Each state & territory has their own incentives for both first home buyers and those building homes.
We recommend that you contact your state government to confirm the incentives that you may be eligible for.
We will always complete a “funds to complete calculation” for the land and for the total project to make sure you have enough money to complete both stages.
The combination of a guarantor home loan with a construction loan is a particularly difficult situation. Most lending systems simply cannot handle this combination and as a result there are delays and errors. Please discuss this with us as we have a couple of lenders that can accept this type of loan
Cost plus / variable cost construction loans
In some cases you may not be able to determine the total cost of construction before your loan is approved so you can apply for a Cost plus / variable cost construction loan.
This type of loan is based upon the plans for any property purchased for the purpose of building, renovation, knock down or rebuilding.
Would you like some help financing a home renovation?
The team at Naritas are experts in delivering timely guidance & finance approvals. We have over 100 lenders on our panel & a high quality team of dedicated credit advisers to steer you efficiently through the approval process.