Construction Loan Structures: What You Need to Know

Understanding Construction Loan Structures

If you're a Department of Home Affairs employee thinking about building a new home, understanding construction loan structures is crucial. Unlike standard home loans where you receive the full loan amount upfront, construction finance works differently. You'll receive funds in stages as your build progresses, which means you'll only charge interest on the amount drawn down at each stage.

This structure protects both you and your lender, ensuring funds are released as work is completed. Let's explore how these structures work and what you need to know before you commence building.

How Progressive Drawdown Works

Construction funding operates on a progressive drawdown system. Rather than receiving the entire loan amount on settlement day, your lender releases funds according to a progress payment schedule. This schedule typically aligns with key building milestones:

1. Base stage (site preparation and foundation)
2. Frame stage
3. Lock-up stage (roof and external walls completed)
4. Fixing stage (internal fittings and finishes)
5. Completion stage

Each time your builder reaches a milestone, they'll request a progress payment. Your lender will then arrange a progress inspection to verify the work has been completed to an acceptable standard. Once approved, the funds are released directly to your registered builder or, if you're undertaking owner builder finance, to you for paying sub-contractors like plumbers and electricians.

Interest Payments During Construction

One significant advantage of construction loan structures is that you only pay interest on funds already drawn down. If your total loan amount is $500,000 but only $150,000 has been released for the base and frame stages, you'll only pay interest on that $150,000.

Most construction loans offer interest-only repayment options during the building phase. This keeps your payments manageable while you're potentially paying rent elsewhere or managing other housing costs. Once construction is complete, your loan typically converts to a standard home loan with principal and interest repayments - this is known as a construction to permanent loan.

Fixed Price Contracts vs Cost Plus Contracts

When applying for construction finance, lenders will want to see your building contract. There are two main types:

Fixed Price Building Contract: This is the most common structure where your builder quotes a set price for the entire project. The price can only change if you request variations or unforeseen issues arise (like discovering rock during excavation). Most lenders prefer fixed price contracts as they provide certainty about the final cost.

Cost Plus Contract: With this arrangement, you pay the actual cost of materials and labour plus a margin for the builder. While this can work well for custom design projects, it's harder to get approved as the final cost is less predictable.

For Department of Home Affairs employees, working with fixed price contracts generally makes the construction loan application process smoother.

Progressive Drawing Fees and Other Costs

Beyond the construction loan interest rate, you'll encounter other costs during your build:

• Progressive Drawing Fee: Lenders charge this fee (typically $200-$400) each time they conduct a progress inspection and release funds
• Development application and council approval fees: Required before you can commence building
• Building insurance: Mandatory during construction
• Interest on land (if applicable): If you've purchased land separately

Land and Construction Packages

Many Department of Home Affairs employees choose land and construction packages, which combine the purchase of suitable land with a building contract. These house & land packages often come from project home builders and can streamline the approval process.

With a land and build loan, you'll typically settle on the land first, then construction begins. You'll need council plans approved and must commence building within a set period from the Disclosure Date (usually 6-12 months). Some lenders offer holding options where you're not required to make full repayments on the land portion until construction starts.

Alternative Construction Finance Options

Construction loan structures aren't just for building new home finance. You can access construction loan options from banks and lenders across Australia for:

• House renovation loan: Major renovations requiring staged payments
• Home improvement loan: Significant upgrades like extensions
• Spec home finance: If you're building to sell
• Custom home finance: For unique architectural designs
• Off the plan finance: For apartments or townhouses under construction

As a renovation finance & mortgage broker, we can help you understand which structure suits your project.

Timeline Considerations

Construction projects typically take 6-12 months, depending on complexity and weather conditions. Your lender will set a maximum construction period (usually 12-18 months) during which the progressive payment schedule must be completed. If your build extends beyond this timeframe, you may need to apply for an extension.

Remember, you need to have your development application and council approval in place before your lender will approve your construction loan application. This can add 2-3 months to your timeline, so plan accordingly.

Quality Construction Matters

Lenders want assurance that your new home will be built to a high standard, which is why they require you to use a registered builder (unless you qualify for owner builder finance). The progress inspection process isn't just about releasing funds - it's about ensuring quality construction at each stage.

If inspections reveal substandard work, your lender may withhold funds until issues are rectified. This protects your investment and ensures you're getting the quality you're paying for.

Additional Payments and Flexibility

Some construction loan structures allow additional payments during the construction phase, which can reduce your overall interest costs. If you receive a bonus or tax refund, putting these funds toward your loan can make a meaningful difference.

Once your build is complete and your loan converts to a standard mortgage, you'll have the same flexibility as any home loan, including the option to make extra repayments and potentially switch from interest-only to principal and interest.

Getting Started with Your Build

Understanding construction loan structures is the first step toward building your dream home. As Department of Home Affairs employees, you may also have access to specific benefits through programs like the Home Guarantee Scheme or 5% Deposit Scheme, which can be combined with construction finance.

Whether you're looking at a land and construction package, planning a custom design, or considering a project home loan, having the right loan structure in place makes all the difference.

At Public Home Loans, we specialise in helping public servants understand their construction funding options. We can access construction loan options from banks and lenders across Australia and find a structure that works for your specific situation, whether you're buying your first home or buying your next home.

Call one of our team or book an appointment at a time that works for you. We'll walk you through the entire process, from understanding progress payment finance to finalising your building loan and watching your new home take shape.