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What is a construction loan?
A construction loan is a purpose-built home loan for building a new home, or completing a major renovation or knockdown-rebuild. Unlike a standard mortgage where you get all the money at once, a construction loan releases funds progressively as your builder completes agreed-upon stages.
During the build, your loan is usually interest-only. This helps manage cash flow, especially if you’re also paying rent or another mortgage. Once the house is finished, the loan typically switches to a standard principal and interest (P&I) home loan.
How it works
- A construction loan funds your build in stages, and you typically only pay interest on the money you’ve used during construction.
- Lenders release funds as ‘progress payments’ after key milestones are hit, like the slab being poured or the frame going up.
- Your building contract is a critical document. Lenders in Australia strongly prefer a ‘fixed-price contract’ as it provides cost certainty.
- The bank will value your project based on its ‘on-completion’ value before approving the loan.
- You’ll need council-approved plans, a signed building contract, and builder’s insurance before you can get final approval.
- A broker can help you understand different lender policies and guide you through the application process.
Typical Construction Loan Stages and Progress Payments
Your building contract will include a progress payment schedule. Lenders use this to release funds directly to your builder.
While the exact percentages can vary, a typical Australian build is funded across six key stages.
| Stage | What’s Involved | Typical Progress Payment |
| 1. Deposit | The initial payment to the builder to kick off the project. | 5% |
| 2. Base/Slab | The foundation is poured, and initial plumbing is laid. | 10% – 15% – 20% |
| 3. Frame | The house frame, roof trusses, and windows are erected. | 15% – 20% |
| 4. Lock-Up | External walls, doors, and windows are installed, securing the house. | 30% – 35% |
| 5. Fixing/Fit-Out | Plastering, tiling, kitchen and bathroom installations are completed. | 20% – 25% |
| 6. Practical Completion | The build is finished, final inspections are passed, and you get the keys. | 5% – 10% |
The exact amounts, number of stages and percentage of funds that your lender will release at each stage will vary depending on a number of factors, such as your particular lender and loan, associated fees and so on.
Your Deposit, Equity, and Contributions
Before the lender starts releasing funds, you need to put your contribution in first. This can be cash savings or equity from land you already own. Lenders may also require you to have a contingency fund (typically 5-10% of the build cost) to cover unexpected expenses.
Your Loan to Value Ratio (LVR) is calculated on the ‘on-completion’ value. If you borrow more than 80%, many lenders require Lenders Mortgage Insurance (LMI), though conditions vary.
Be aware that financing an owner-builder project can be difficult, as many Australian lenders have very restrictive policies.
Construction Contracts Explained
Your building contract is one of the most vital documents. Lenders review it carefully to ensure the project is viable and risks are managed. Understanding the contract type is essential.
The different types of building contracts
| Contract Type | Pros | Cons | Typical Lender View |
| Fixed-Price | Cost certainty, as the price is agreed upfront. Easier to budget. | Less flexible for changes. Variations can be costly. | Preferred. Offers the most security for the lender. |
| Cost-Plus | More flexibility. Potential for savings if costs come in under budget. | High risk of budget blowouts. No cost certainty. | High Risk. Most lenders avoid or have very strict rules. |
| Design & Construct | Streamlined process with one company managing design and build. | Can be more expensive. Less control over individual elements. | Accepted. Often treated like a fixed-price contract. |
Valuations and Cost Control
Lenders need to be sure the finished property will be worth the total cost of the land and construction. They arrange an ‘on-completion’ valuation before the loan is approved.
If the valuer decides the finished home will be worth less than the total cost, this creates a ‘valuation shortfall’, and you’ll have to fund the difference yourself.
To manage your budget, try to lock in quotes with suppliers, get written approval from the lender for any variations, and protect your contingency fund for genuine surprises.
How much can I borrow?
Use our home loan borrowing calculator to estimate how much you can afford to borrow.
Lender Requirements in Australia
To get your construction loan approved in Australia, your lender will need a comprehensive file. Key documents may include:
- Building plans
- A signed, fixed-price building contract.
- Copies of your builder’s license and insurance
- Evidence of your contribution (e.g., cash, equity).
- A Quantity Surveyor (QS) report may be required for large or complex projects.
Timeline and Cash Flow
A construction project is a long-term commitment, often taking 12 months or more from approval to completion. During the build, you’ll need to manage your cash flow for the interest-only payments. You can either pay this monthly or ask the lender to ‘capitalise’ the interest (add it to the loan balance), though not all lenders offer this.
Risks and How to Manage Them
- Builder Solvency: Do your due diligence. Check your builder’s license, references, and recent work.
- Cost Overruns: A fixed-price contract and a contingency fund can be a source of protection.
- Delays: These are common. Consider clear timelines and contractual clauses for ‘liquidated damages’ (penalties for the builder if they run late).
- Valuation Shortfalls: Work with a broker to understand the local market and avoid over-capitalising on your build.
Action Checklist for Your Construction Loan
- Prepare Your Finances: Gather payslips, bank statements, and proof of savings.
- Choose Your Builder: Get multiple quotes and review their contracts and licenses thoroughly.
- Ask Questions: Ask your builder about their process and ask your broker about lender-specific construction loan policies.
- Engage an experienced Mortgage Broker: A mortgage broker specialising in construction finance is your greatest asset. They can match you with the right lender, help you compare policies, and ensure the loan is structured correctly.
Ready to start your building journey? Contact our Export Mortgage Brokers today to explore your options.
Disclaimer:
The information is provided by Yellow Brick Road Finance Pty. Limited ACN 128 708 109 Australian Credit Licence 393195 and does not take your personal objectives, financial situation or needs into account. Consider its appropriateness to these factors before deciding whether to act on it.
