What is a construction loan?

Instead of one lump sum at settlement, the lender releases money as the build reaches set stages. The builder submits a claim for work completed, the lender sends a valuer or inspector to confirm the stage and the value of the work, and then pays the claim to the builder or, if the contract requires, to you. Variations and delays can hold up a draw and add to the cost.

During the build you normally pay interest only on what has been drawn, so cashflow is lighter, although total interest can be higher if draws come early or the project runs slow. Once practical completion is certified, the loan converts to a standard mortgage with principal and interest repayments. Some lenders bill the interest monthly; others capitalise it during the build.

With a builder-managed loan the lender deals mostly with the builder on progress claims; this is the usual set-up where the builder is established and works to a fixed-price contract. With an owner-builder loan you manage the build and the claims yourself, and lenders usually want evidence of skills, trade experience or past builds, plus more inspections and paperwork.

A split loan draws part of the facility as progress payments while the rest sits in an offset or standard home loan, keeping the build finance separate from long-term mortgage debt. A line of credit offers flexibility, but lenders rarely use one for staged progress billing on a build.

Commercial and development construction finance works the same way at a larger scale: the lender provides the senior facility, sizes it against both the value on completion and the total cost to build, and often wants presales or pre-leases before the first draw. Mezzanine finance can sit behind it.

Lenders assess both you and the project. Expect to show income and serviceability, genuine savings, the source of your deposit and your credit history, with the deposit sized to meet the lender's LVR limit. On the project side they want the building contract, working drawings and specifications, council approval and building permit, a fixed-price quote, and the builder's ABN, licence, references and insurance.

Costs include the usual establishment and valuation fees plus build-specific ones: a fee per progress draw, inspection fees at each stage, home warranty and contract works insurance, and lenders mortgage insurance if your LVR is high. Lenders may also build a contingency allowance into the valuation, and a retention amount held back for defects is often written into the contract.