You might be thinking about building your own home, but are wondering how does construction financing work?
Today we’ll show you how construction financing works, what documents you are going to need to arrange a building home loan and how to process progress payments to get your builder paid!
Including 3 examples, and case studies to help you understand construction financing.
Let’s dive right in…
- What is Construction Financing?
- Why is Construction Financing Complicated?
- What Construction Loan documents do I need?
- How does Construction Financing Work?
- What does a standard HIA progress payment schedule involve?
- How Does a Bank Pay the Builder Directly?
- Can all banks do building loans?
What is Construction Financing?
Buying a finished house and building a property are two completely different things. Construction financing is used for renovation purposes or to construct a home from scratch (or doing substantial renovations).
It is a specialised lending option for individuals who are renovating or building a house, as it facilitates them in successfully completing the entire construction process.
This financing option is available as construction finance or home loan with construction facility where the bank will pay the builder in smaller parts called progress payments while building the home.
Why is Construction Financing Complicated?
It is not easy to build a house. In fact, it is a very complex process with the involvement of multiple stakeholders.
The following are the key stakeholders involved in the construction of a home:
- ✅ Solicitors
- ✅ Contractors
- ✅ Builders
- ✅ Lenders
- ✅ Quantity Surveyor
- ✅ Accountants
- ✅ The Council
There are so many parties involved in the process, which can be quite challenging at times. For example, it is quite likely that one expert may not be able to understand the field of the other party. This can lead to errors and complications.
A large number of financial institutions and mortgage brokers are not familiar with construction at all. As a consequence, there are a number of challenges in construction financing, including approval of incorrect loan amount and delay in loan disbursement due to constantly changing requirements.
What Construction Loan documents do I need?
As with a regular home loan, you are going to need your latest payslips, a few months savings statements and other supporting documents but you will need a few extra things to get a construction home loan.
- 1. Building Contract: The building contract contains things like the construction stages, progress payment schedule, how long the build time is and the price to construct your new home. This is an example of a full Queensland HIA Building Contract. The good news is that in Queensland you do not need to sign the building contract to get your finance approved!
- 2. Building Plans: Before your home loan is approved you do not need council approved building plans, but they will give the valuer an idea of the property the layout and size of the house you are building.
- 3. Specifications: The building specifications give the bank, and valuer an idea on the types of finishes you will be using in the house and the quality of materials like benchtops and appliances. This can make a big difference in the final valuation of the property.
- 4. Extra Quotes: Extra quotes can be anything from getting solar panels installed to a pool and additional landscaping. It is worth giving these to the bank’s valuer so they can factor in if these will improve the value of the overall property.
How does Construction Financing Work?
Construction financing is different from a regular home loan. For regular financing, a person receives a lump sum loan at the date of settlement. Whereas, in construction financing, a person receives progress payments from financial institutions at various stages of construction.
What are the Stages of Construction?
There are a typically five progress payments at different stages, including:
- 🏗 Slabs poured
- 🏗 Frame up
- 🏗 Completion of brickwork
- 🏗 Lock up
- 🏗 Practical completion
What does a standard HIA progress payment schedule involve?
With this being the case, the banks will want you to follow the standard HIA Progress Payment Schedule which has payments split like this:
🏡 Deposit: 5%
🏡 Base 15%
🏡 Frame 20%
🏡 Enclosed 25%
🏡 Fixing 20%
🏡 Practical Completion 15%
Using an Independent Valuer
Some financial institutions or banks hire an independent valuer who verifies whether the work has been completed at the standard or not. The next payment is released only when the valuer provides verification of the work. This can be an effective measure to evaluate the progress of work.
Determining the Loan Value
Banks need a copy of a tender or a building contract, and the construction plans along with the loan application. The valuer assesses the value of a property after completion and also calculates the estimated loan value.
The loan value represents the lower of the two:
- On completion value, or
- Land price plus construction cost
Additional Documents Required from the Builder
Once the builder starts receiving the progress payment after loan approval, he needs 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 progress payments to the builder. For example, once you receive an invoice from a builder:
- Complete the drawdown request form and sign it.
- The form and invoice are sent 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.
The same process is repeated at every stage of construction.
The progress payments are also called the drawdowns. A person is liable to pay interest on the drawdown amount. For example, you get a loan approval for $300,000. However, you only draw $50,000 at the beginning. This means you are only required to pay the interest due on the drawdown amount until you draw further amount.
At the time of construction, the borrower only pays the interest as loan repayment. This provides comfort by reducing financial burden during a stressful period.
You can either convert the loan into two options, i.e.
- principal and interest, or
- you can continue to keep it as interest only.
This, however, depends on the lender and financing option you avail.
It is very important to know the mechanism of construction financing and how it works. It allows you to prepare a good plan and have all the documents ready, along with doing a good estimate of the overall cost.
Chat with our team at Hunter Galloway now about organising your construction finance now, call us on 1300 088 065 or get in touch here.
Can all banks do building loans?
While most of the major banks can do building loans and construction finance, not all smaller lender and online banks can offer it.
The reason being, from a banks perspective construction finance, is very time-consuming and carries more risk than a regular home loan.
After settlement, the lender needs a team to process progress payments, and make sure the builder completes the work.
If the bank is slow at process progress payments, your builder can get frustrated and delay things so you want to work with a bank that is good at the construction process and can make payments quickly.
Right now, in 2019 smaller and online lenders like UBank and ING Direct do not allow building and renovation loans.
Prevent your deal from being declined by talking with our team at Hunter Galloway, call us on 1300 088 065 or get in touch here.
Speak to Construction Financing Experts
If you would like to chat about building a new home and getting a home loan we’d be delighted to help you out, speak with one of our experienced mortgage brokers to walk through the next steps with you.
At Hunter Galloway we help home buyers and those wanting to build a new home get ahead in this competitive market, we give you the actual strategies that have helped other home buyers like you secure a property when there have been 5 other offers on the table! Enquire online or give us a call on 1300 088 065.