Understanding How Construction Loans Work in Australia 

Buying an established house usually involves one settlement and one lump-sum payment. Building a new home works differently. A construction loan releases money gradually as the building work progresses, rather than providing the full approved amount at the beginning.

Understanding how construction finance works before signing a building contract can help you prepare for progress payments, valuations, possible cost variations and lender requirements. It can also reduce the risk of unexpected delays during the building process.

The Money Is Released in Stages

A construction loan does not release the full approved amount at settlement. Instead, funds are paid progressively as different stages of the building work are completed. These payments are commonly known as progress payments or drawdowns.

The payment stages normally follow the construction schedule included in the building contract. Common stages may include:

• Deposit

• Base or slab

• Frame

• Lock-up

• Fixing

• Practical completion

The exact names and number of stages may vary depending on the builder, state, building contract and lender.

Before releasing each progress payment, the lender may arrange for a valuer or inspector to confirm that the relevant construction stage has been completed. The builder submits an invoice, the completed work is checked and the lender releases the approved payment directly to the builder.

This process helps the lender confirm that the borrowed funds are being used for the approved building project.

You Only Pay Interest on What Has Been Drawn

One of the main differences between a construction loan and a standard home loan is how interest is calculated during the building period.

During construction, borrowers are generally charged interest only on the amount that has already been released. They are not normally charged interest on the full approved construction amount from the first day.

For example, during the early stages of the project, only the deposit and slab payments may have been drawn. Interest is therefore calculated on those released funds. As the building progresses and more payments are made, the outstanding loan balance increases, and the interest cost may also rise.

Many construction loans operate on an interest-only basis during the building period. Once construction is complete and the final payment has been released, the loan may convert to principal-and-interest repayments.

This arrangement can help manage costs during construction, particularly for borrowers who are also paying rent or meeting other accommodation expenses while their new home is being built.

The Land Component

When a borrower is purchasing land and building a home, the land purchase and construction finance may be arranged through the same loan facility.

The land usually settles first and is funded as a standard property purchase. The construction portion of the loan is then released progressively after building work begins.

The lender will generally consider the expected value of the completed property. This is known as the on-completion value. It represents what the land and finished home are expected to be worth home is being built.

The Land after construction.

The on-completion value is not automatically equal to the total amount spent on the land and building contract. When the valuation is lower than the combined project cost, the borrower may need to contribute additional funds.

This can affect borrowing capacity, the required deposit and whether the construction loan can proceed as planned.

A construction loan broker will usually push for an early indicative valuation precisely because of this risk.

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Image alt text: Building plans and fixed price contract required for construction loan approval

What Lenders Want From the Building Contract

The building contract is one of the most important documents assessed during a construction loan application. Lenders generally want clear information about the total building cost, construction stages, builder and approved plans.

A Fixed-Price Building Contract

Many lenders prefer a fixed-price contract because it provides a clearly stated total building cost.

Cost-plus contracts may still be considered in some circumstances, but fewer lenders may accept them because the final project cost is less certain.

A Registered and Licensed Builder

The lender will normally require the work to be completed by a properly registered or licensed builder.

The builder may also need to hold relevant insurance, including home warranty insurance or builders indemnity insurance where required under the applicable state scheme.

Complete Plans and Specifications

The loan application may require complete building plans, specifications, council approval or certification from the relevant authority.

These documents help the lender and valuer understand what is being built and estimate the completed property’s value.

A Suitable Progress-Payment Schedule

The progress-payment schedule should generally match recognised construction stages.

A lender may examine the contract more closely when a builder requests an unusually high proportion of the total price during the early stages. A heavily front-loaded payment schedule can increase risk because too much money may be released before enough work has been completed.

Variations Are Usually the Borrower’s Responsibility

A variation occurs when the borrower requests a change after the original building contract has been signed.

Examples may include:

• Upgrading the kitchen

• Adding another room

• Moving an internal wall

• Changing flooring or fixtures

• Adding landscaping or external features

These changes can increase the total building cost. However, the original construction loan approval is normally based on the signed contract, approved plans and initial valuation.

Additional variation costs may therefore need to be paid from the borrower’s own funds.

In some situations, a borrower may request an increase to the loan. This could require another financial assessment, updated supporting documents and a new valuation. It may also delay the project.

Finalising major design decisions before construction begins can help reduce unexpected variation costs.

Practical Advice Before Starting Construction

Preparing carefully before signing the building contract can make the construction finance process more manageable.

Maintain a Contingency Fund

Consider keeping a separate contingency amount for unexpected expenses. A buffer of approximately five to ten percent of the building cost is commonly considered, although the appropriate amount will depend on the project and the borrower’s circumstances.

The contingency fund should ideally remain available rather than being included in planned spending.

Confirm Finance Before Signing

Make sure the proposed finance covers the land purchase, building contract and associated costs before entering into binding commitments.

Signing a contract before confirming borrowing capacity and lender requirements may expose the borrower to financial and contractual risks.

Understand the Construction Period

Construction loan approvals usually include a permitted building period. Depending on the lender and project, this may commonly be between twelve and twenty-four months.

When construction takes longer, an extension may be required. Extensions may be available, but they should not be assumed to be automatic.

Review Every Building Stage

The lender’s valuer checks whether a construction stage has been completed sufficiently for a progress payment to be released. This is different from conducting a detailed building-quality inspection.

The valuer is working for the lender and is not necessarily checking every aspect of workmanship.

Borrowers may choose to inspect the work themselves or engage an independent building inspector at appropriate stages of construction.

Plan the Finance Before the Building Contract

Construction lending involves more than comparing interest rates. The lender must also assess the land, building contract, project cost, builder, payment schedule, completed value and the borrower’s financial position.

Starting the finance discussion early can help identify possible valuation shortfalls, unacceptable contract terms or deposit requirements before the borrower becomes fully committed.

Ezy Loans Australia arranges construction lending across a panel of Australian lenders, and the useful conversation is the one that happens before the building contract is signed. Learn more from Ezy Loans Australia in Perth.