Construction loans

Are you thinking of building a home and wondering how construction loans work? You’ve come to the right place.

Construction loans

Construction loans in Australia are different to standard home loans. It’s important to understand the key differences before you apply to build your dream home. Read on to find out what you need to know, including how to get your construction loan.

How do construction loans differ from standard home loans?

Construction loans have two phases:

  • Phase 1 finances your land purchase.
  • Phase 2 progressively finances the building of your home.

These two phases obviously occur at different times because it takes time to build a home. 

Both loan amounts may (or may not) be transferred to the same third party. For example, if you buy land off a developer who is also a builder, the developer/builder will receive both phases.  You might even be an owner/builder yourself.

Alternatively, you may buy your land off a developer and arrange a separate builder for your home. The developer would receive your phase 1 finance and the builder would subsequently receive your phase 2 finance. 

Standard loans for established homes on the other hand only have one finance phase. Once your home loan is approved, all the funds you borrow will be available on your settlement date. This is the day the funds are transferred to the seller and you take ownership of the established home.

How do construction loans work?

Phase 1 of construction finance for the purchase of land are usually principal and interest loans. This means your regular repayments will cover both the amount you borrow (the principal) plus interest.

Phase 2 of construction finance commences once a home starts being built. Your builder will progressively get paid once certain construction milestones are reached. This is called ‘loan drawdown’.

There are usually five drawdown stages. They happen when the following milestones are reached.

  • Stage 1: the concrete slab/foundations are laid.
  • Stage 2: the home frame is completed.
  • Stage 3: most external work is completed and the home can be locked up to prevent unauthorised internal access.
  • Stage 4: the home is fitted out internally.
  • Stage 5: the home is completed and ready for handover to you.

The loan drawdown amount at each stage of the building process will reflect the cost of each stage.

Both you and your lender will usually inspect the property as each milestone is reached before approving funds for release. Once this approval is in place, your lender will pay the relevant drawdown funds to your builder.

Drawdown repayments on construction loans are usually interest-only. They revert to standard principal and interest repayments when the drawdown is complete.

What documents do you need to apply for construction loans?

Construction finance requires you to provide additional documents to the ones you need to supply for a standard home loan.

Documents that you usually need to supply for a standard home loan include:

  • Suitable identification.

       For example, your driver’s licence, passport and Medicare card.

  • Proof of income.

       For example, pay slips, tax returns or business financial statements if you’re self-employed.

  • Evidence of any assets you own

       For example, if you own your car and any bank account savings you have.

  • Details or any debts you have.

       For example, personal loans or credit cards

  • A budget of your monthly income and expenses.

       This is important to show that you can meet your loan repayments. You can use our calculator to work out your repayments on different loan amounts.

Additional documents that you usually need to supply for construction loans include:

  • your building contract.
  • your building plans.
  • council approvals to build your home.
  • your builder’s current licensing/registration and insurance details.

How much deposit do you need for a construction loan?

The criteria of different lenders varies. Some will be prepared to lend with a deposit of as little as 5%, but most others will require more.

It’s important to understand that the more deposit you can provide, the lower your risk to the lender. You should then be able to access better terms and conditions. For example, a lower interest rate and/or lower fees.

Lenders will calculate your loan-to-value ratio (LVR) as part of assessing your construction loan application. This is the estimated value of your home once its built divided by the deposit you can provide. If your LVR is higher than 80%, you’ll usually be required to pay for lenders’ mortgage insurance (LMI).

You’ll usually have to use up all of your deposit before accessing any approved phase 1 or 2 construction loan funds.

The pros and cons of construction loans



Payments aren’t released to your builder until you and your lender approve each construction milestone. That gives you the opportunity to inspect the building work on your home to make sure you’re happy with it.

You may be able to access a government grant to help you with your deposit

If you’re a first home buyer, all Australian States and Territories offer the first home owner grant (except the ACT). Grant amounts and eligibility conditions vary depending on where you want to build.

Lower repayments while your loan is being progressively drawn down

You’re not repaying the full amount of your loan straight away until it is fully drawn down. This means that you’ll have more money to spend on other things you might need like furniture or appliances.

In addition, you are usually only making interest-only payments on the building component of your loan.

Pay less interest while your loan is being progressively drawn down

You’re only charged interest on the amount you’ve drawn down, not on the full amount until your home is completed.  

You only pay stamp duty on your land, not on the home you build     

This can be a major cost saving compared to buying an  existing home. That’s because you pay stamp duty on the total price of an existing home (which includes both house and land).

Stamp duty rates vary across Australian States and Territories, but you can save yourself several thousand dollars by building instead.


You may have to provide a higher deposit

A higher deposit lowers the lender’s risk. It may take you more time to save a higher deposit unless you can access government grants like the first home own  er grant or the first home loan deposit scheme.

The interest rate may be higher until your home is completed

Interest rates on construction loans can be higher than standard home loan rates to compensate the lender for building risk. However, the rate usually reverts to the lender’s standard home loan rate once the loan is fully drawn down.

The interest rate may be higher until your home is completed

Interest rates on construction loans can be higher than standard home loan rates to compensate the lender for building risk. However, the rate usually reverts to the lender’s standard home loan rate once the loan is fully drawn down.

Tips for construction loans

Do your research!

Make sure you compare different lenders. Use the comparison rate to work out the total cost of each construction loan so you can find the best deal. The comparison rate includes the cost of interest plus lender fees and charges. You can research home loan rates easily online via comparison sites like the one we provide here at Savvy.

Get a pre-approval for your construction loan limit before you design your home.

That allows you to design your home to suit your budget. Otherwise, you can waste a lot of time designing a home you can’t afford.

Make sure you allow for contingencies (potential additional expenses) in your pre-approved construction loan amount. This gives you some room to move if your building or personal circumstances change.

Negotiate a fixed price contract with your builder if you can

As the name suggests, a fixed price contract means that your construction costs can’t unexpectedly blowout during the building process.  It gives you security and peace of mind.

Don’t make changes to your building contract after your construction loan is approved.

If you do, it’s likely that your construction loan will need to be reassessed. You mightn’t get your changes approved in the worst-case scenario. Even if you do, it can be time- consuming to get your loan reassessed. If it is, it will delay the building of your home.

What else you need to know about construction loans

Where can you get construction loans in Australia?

Construction finance is available from a wide variety of Australian  lenders, including many banks, credit unions and building societies. The loan terms and conditions for each lender will vary.  It’s important to shop around to find the best one for your needs.

What if I can’t negotiate a fixed price contract with my builder?

Sometimes it may not be possible to get a fixed price contract with a builder. Instead, they will provide you with an estimate. Builders do this to protect themselves against unforeseen circumstances, or changes to labour costs or building materials.

If you can’t get a fixed price contract, you will need to be approved for a ‘cost plus’ construction loan. This type of finance is also known as a ‘variable’ construction loan.

What is a ‘cost plus/variable’ construction loan?

As the name suggests, it’s approval for construction loan finance up to a set limit. It caters for situations where building costs can vary (in other words, if you don’t have a fixed price contract).

You’ll still have to convince a lender of your ability to repay the maximum amount to get your loan approved. Use our calculator to work out your potential borrowing power.

Do I have to pay for construction insurance?

Yes, you will need insurance to protect yourself financially against potential construction issues. For example, the cost of fixing structural defects due to builder negligence. You’ll also need public liability insurance for the construction site. Cover against non-completion of the work due to unforeseen issues like builder insolvency may also be necessary.