Construction Finance: Considerations When Building a House
Not everyone is able to find their dream home for sale on the market, some accordingly decide to build their dream home. Let’s assume that you have secured your ideal block of land and your approved loan limit may include conditional approval for funding needed to build the house. This sets your budget for the proposed new house and will impact on determining the right builder for the job.
Before choosing a builder, your research and design process may have yielded finished design documents, either drawn by an architect or draftsman for presentation to a builder for review and pricing.
Two common ways to choose a builder are:
choose a preferred builder and invite them to prepare a quotation or ‘tender’ (it’s recommended that more than one builder is invited to tender)
call open or selective tenders from a range of builders and choose on the basis of price.
Each method delivers a builder and a quotation but one emphasises price and the other, preferred builder. In either case, note in your tender documents that you are ‘not obliged to accept the lowest or any tender’.
Your architect or draftsman can generally also help choose builders to tender for a project, based on their recommendations and past experience. The principal role of a builder is to coordinate the building works as project manager. This role includes;
supervising and coordinating each trade; sourcing, quantifying and coordinating delivery of materials; and, most importantly,
quality-assuring the entire process.
Once a registered builder has been engaged, you will need to provide the following documents required by the banks to support your construction loan;
Copy of signed Industry Standard Fixed Price Contract, dated and signed by all parties.
Copy of council approved plans/specifications/permits.
Copies of insurance policies (required prior to first progress payment):
Builders All Risk/Public Liability Insurance
Domestic/Home Warranty Insurance (lender dependent)
The below tabled stages must be evident in the builder’s contract as the bank will disperse funds accordingly during construction. Note that, banks do not like progressive claims schedules that are front loaded, i.e. where the builder seeks to claim bulk of the construction cost during the first 2 or 3 stages of the construction.
Where a front-loaded building contract is submitted, the bank may respond by requesting the borrower to contribute more funds upfront, amend the stage claim amounts or in an extreme case, reject the contract all together.
| Construction Stage | Expected Progress |
| Base | Concrete slab complete or footings and base brickwork complete |
| Frame | House frame complete and approved by building surveyor/inspector |
| Lock Up | Windows/doors, roofing, brickwork, insulation |
| Fixing | Plaster, kitchen cupboards, appliances, bathroom, toilet, laundry fittings/tiling, heating, fixing/internal doors, etc., plumbing, electrical, painting |
| Completion | Fencing, site clean-up, final payment to builder |
With the building contract finalised, you must provide the documents listed earlier to the lender to enable them to order a valuation and determine the forecast value of the property on completion. The valuer’s role is to cost the house and confirm if it is comparable to other similar properties on the market, typically the valuer comes to the ‘as if complete’ value by adding the land and build cost together.
This method of valuation is not always applied, if the valuer concludes that the house being built is over capitalised for the location, the valuation may come in lower than the ‘as if complete’ value. Once the valuer confirms the value on completion, the loan LVR is set against this, common ratio banks lend is 80% of the ‘as if complete’ value.
Once your loan has final approval and you have signed all required mortgage documents, funds will be held in account by the bank to be progressively drawn down according to construction stages – (refer Table 1). It is very rare for a lender to give funds for construction as ‘cash-out’ as they want to ensure that the house is actually constructed due to the security value being lent against is based on house and land.
You are required to make contribution from your own funds towards your construction loan. However, the amount that you are required to contribute and at what stage depends on the lender policy. Most will require that the owner’s contribution be deposited into the loan account on settlement so that the lender can draw payments from this before using loan funds.
At different stages of construction, you or your builder will require payment. To get access to these funds, you or your builder must provide the following to the lender:
• A completed and signed Progress Claim Certificate
• Copies of all relevant builder’s claims, invoices or receipts
Invoices are required before any claim relating to them can be processed. Invoices for the lender must:
• Be on an official company letterhead
• Include the builder’s ABN
• Describe any change to the amount you have previously agreed to pay the builder and the reasons why
• Describe the preferred payment method and disclose GST payable
• Be clearly marked as a tax invoice
During construction, lenders will require inspections and valuation of work completed. This is to satisfy the lender that the payment being claimed is for work completed as per contracted stages. At minimum, lenders will order valuation:
• Prior to commencement of building, to estimate value of land and proposed improvements
• When the first progress claim is requested
• When the final progress claim is requested
Cost over-runs due to variations during construction are common, payments can only be made up to the valuation amount for each stage of construction. If the loan balance plus construction claim exceeds the funds approved, then this is considered a cost overrun.
You are responsible for paying any cost overruns associated with the construction from your own funds. Progress payments may be stopped immediately by the lender until this cost overrun has been met.
On completion of the build, before your final progressive payment can be made, you will need to provide lender with the following documents:
• For new homes: a copy of the occupancy certificate or interim occupancy certificate where only external items such as driveway and landscaping (not typically included in construction valuation) are outstanding
• For renovations and extensions: a copy of the final inspection certificate
• A copy of the building insurance/fire policy may also be requested
Most construction loans are on an interest only basis during the build stage and repayment is calculated on the drawn down amount only. This is to assist the borrower manage cost, especially if they have rent or an existing mortgage commitment. Once the interest only period expires, your loan will then convert to principal & interest.
If you finish building before the end of your interest only period, you can request the lender vary the contract to bring the interest only period to an end and start your principal and interest repayments so that you can start building equity in your new property.