Construction Finance is not too different to the standard forms of finance, but has a couple of unique features that should be understood.
Most lenders will offer construction finance, so for house and land packages, these lenders will need to be approached. There are other lenders which won’t finance construction, but are the best lender or most appropriate given your situation, so depending on the builder or developer and their offer, sometimes a house can still be conditionally financed off the plan and then once built, a valuation can be done and this will normally satisfy these lenders.
Construction finance changes in a few stages, so we’ll go through that. Firstly a loan application is made for the whole amount of land plus construction per a fixed price contract. Sometimes the land can be bought separately but this will affect stamp duty in the cases of first home buyers, so you’ll need to be aware of that and how to get around it.
When the loan settles, only the land portion will be drawn down. This will mean that you’ll start paying your repayments on only the land component, in a principal and interest schedule (for those with a P&I loan). This may go on for a few months depending on the builder’s commitments.
Once the builder starts work, the loan will transfer into an interest only loan, so you won’t be paying off any principal for the time being. The construction components of the loan will then be drawn down in increments, as noted in your mortgage documents. So the builder will need to complete certain points in the construction process prior to you getting your next drawdown to pay him, and at each point a bank representative will inspect the building to make sure the work has been done properly.
The interest only aspect of the repayments makes your cash outgoings less painful during this time, which can often last for several months. This is very helpful if you are paying rent or a mortgage elsewhere. Still, for some people this can be very difficult, so there is a lender which can offer rent assistance as well during construction, allowing its customers to pay only a few hundred dollars a month and capitalising the interest until construction is complete.
When construction is finished, the final stage of the loan will be drawn down and the loan then reverts to principal and interest, so your repayments will then be at their highest but will start paying down the loan.