Thinking about building a new home? Construction financing can help.
In this article, we will help you figure out construction financing better so you can make the right decision.
So, let’s dive right into it:
What is Construction Financing?
There are two ways you can become an owner of a house: either you buy a furnished house or you build one yourself. Construction financing comes into play for the latter.
You can avail of construction financing if you are building a house from scratch.
This financing option is available as construction finance or a home loan with a construction facility. Under this financing option, the bank pays the builder in small parts called progress payments during the construction process.
Is Construction Financing Complicated?
Building a house is complicated so it warrants some complications in the financing process.
Yes, it is a complicated process that involves multiple shareholders.
Here’s a list of key stakeholders that are involved in the construction financing process:
- Quantity Surveyor
- The Council
The involvement of so many parties makes this loan a complicated process. Financial institutions and mortgage brokers differ in terms of construction. Moreover, there are a number of challenges including approval of incorrect loan amounts and delays in loan disbursement due to constantly changing environments.
Construction Financing Documents
As with any other loan, you will have to procure your latest payslips, savings statements for a few months, and several other supporting documents. You will also need a few extra documents or may need appropriate consultation with a construction & development finance broker to avail construction financing loans including:
Building Contract: The building contract will include things such as construction stages, progress payment schedule, construction period and price.
Building Plans: You don’t need to council approved building plans but it will help the valuer an idea of the property and the size of the house you are building.
Specifications: You will have to provide the bank and the valuer an idea of the types of finishes you want to use in the house and the materials like benchtops and appliances. And Building specifications are essential for providing such information.
Extra Quotes: If you are planning on installing solar panels or a pool in your house, you will need to get extra quotes. Providing these to your bank will help with improving the value of the overall property.
How Does Construction Financing Work?
Construction financing is not similar to regular home loans. In regular financing, you receive a lump sum loan at the date of settlement. However, in terms of construction financing, you get progress payments at various stages of construction.
Here are some of those stages of construction:
- Slabs poured
- Completion of brickwork
- Lock up
- Practical completion
What Does a Standard HIA Progress Payment Schedule Include?
Banks often say your builder is not following the proper HIA Progress Payment Schedule, which means they have changed accounts that you need to pay at different stages of construction. Usually, builders want to get paid upfront but the banks want to spread the payment over the time it takes for construction.
The banks will want you to follow the standard HIA Progress Payment Schedule which includes payment splits like:
- Deposit: 5%
- Base 15%
- Frame 20%
- Enclosed 25%
- Fixing 20%
- Practical Completion 15%
Using an Independent Valuer
Some banks and financial institutions hire independent valuers who are tasked to verify whether the construction has been done as per the standards. The bank only releases the next payment when the valuer approves it.
Determining the loan value
Banks also need a copy of a tender or a building contract, construction plan and loan application. The valuer analyzes the value of the property after completion and calculates the estimated loan value.
The loan value will depend: on completion value or land price plus construction cost.
Additional documents required from the builder
After the loan is approved, the builder will start receiving the progress payments and then they would need to provide the following documents:
- The final plan approved by the council
- Insurance plan
- Drawdown schedule
How Does a Bank Pay the Builder Directly?
You can ask your bank to send the progress payment directly to your builder. Once you receive an invoice from a builder, you can
- Complete the drawdown request form and sign it.
- Send the form and invoice to the construction department of your bank.
- The bank may need a valuation to verify the completed work.
- Your lender releases further payment to your builder within five business days.
Also known as drawdowns, the progress payment incurs interest. For instance, if you get a loan approval of $300,000 but you only draw $50,000 at the beginning, you will only be required to pay the interest due on the drawdown amount until you draw more amount.
During the construction process, the borrower only pays the interest as loan repayment. This reduces the financial burden, helping you ease up a bit.
You can convert the loan in two ways:
- principal and interest, or
- you can continue to keep it as interest only
Do All Banks Offer Building Loans?
The majority of the banks offer building loans and construction finance. However, the process tends to differ according to the capacity of the bank. And not all online banks and smaller lenders can offer it.
According to the bank, construction finance is time-consuming and carries a lot of risks with it.
If the bank delays the progress payment, your builder might be unhappy with the arrangements and this could hurt your construction process.