How construction loans work, from contract to completion

The short answer

The lender approves the whole loan up front and then releases it in stages as the build progresses. Interest is charged only on the amount drawn so far, so the repayment starts small and climbs.

When the build is finished the loan converts to a normal home loan and repayments begin on the full balance. That conversion is the moment the real repayment starts, and it is worth budgeting for from the beginning.

How the drawdowns actually work

Your builder invoices at agreed points in the build. The lender inspects or values as required, then pays the builder directly rather than paying you.

1. 1

   The land is settled first, where you are buying it

   On a two-contract purchase the land settles as its own transaction, and duty is generally assessed on the land at that point.

2. 2

   The builder invoices at each agreed stage

   The stages and the amounts come out of your building contract, so read that schedule before you sign it.

3. 3

   The lender checks the work before releasing funds

   Usually a progress inspection or a valuer's report confirming the stage is complete. It protects the lender, and it also protects you from paying ahead of the work.

4. 4

   Funds are paid to the builder

   Straight to the builder, not into your account. Your loan balance goes up by that amount and so does your interest.

5. 5

   The loan converts on completion

   Once the build is finished and the final drawdown is made, the loan becomes an ordinary home loan on the full balance.

How a lender values a house that is not there yet

The lender values the property as if complete, working from the plans, the specifications and the building contract. That valuation is what the lending is sized against.

It means the paperwork carries more weight than on a normal purchase. A vague specification or an unusual design gives the valuer less to work with, and a cautious valuation reduces what can be lent.

Variations after approval can move that valuation. Significant changes are worth raising with your broker before they are signed rather than after, because the funding was sized against the original contract.

What lenders want to see in the contract

On a construction file the building contract is assessed as closely as your income is. A lender is funding a promise to build something, and the contract is the promise.

• A fixed price contract with a registered builder, which is what most lenders are comfortable with
• A clear schedule of stages and the amount payable at each one
• Plans and specifications detailed enough for a valuer to work from
• Council or relevant approvals, where they are required before construction
• Builder's insurance and warranty cover as required in Western Australia
• A realistic build period, because lenders set a deadline for completion

Owner-builder, knockdown rebuild and renovation

Not every build is a house and land package, and the funding differs in each case. The further you move from a fixed price contract with a registered builder, the fewer lenders are available.

Each of those has its own page on this site, because the differences are large enough that generic construction advice is close to useless.

Where builds come unstuck

• Signing a building contract before the finance structure has been checked
• Variations that push the cost above what was approved, with no funding for the difference
• A build running past the lender's completion deadline
• A conservative as-if-complete valuation that reduces the amount lent
• Circumstances changing during a long build, which the lender reassesses
• Underestimating the cost of paying interest and rent at the same time

None of those are exotic and most are avoidable. They come from the same root, which is that a build is a moving target and the finance was sized against one particular version of it.

Where to go next on this site

Find the kind of build you are doing. The funding is different enough in each case to be worth reading the specific page.

The pre-approval guide is worth reading before you commit to a build, because a construction pre-approval behaves differently from a purchase one.