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How do construction loans work?

Green Construction Loan

Low rate construction loan with added benefits for homeowners.

  • 2.63%
    discount var rate p.a.++
  • 3.08%
    comparison rate p.a.*

Green Construction Loan

Low rate construction loan with added benefits for homeowners.

  • 2.63%
    discount var rate p.a.++
  • 3.08%
    comparison rate p.a.*

A construction loan is a type of home loan that's designed for people who are building their own home as opposed to buying one.

Unlike a regular home loan, a construction or building loan covers the expenses you incur as they happen throughout the stages of construction.
Construction loans have a completely different structure to a traditional mortgage. A construction loan divides your loan into stages based on what part of the building process you're in.
This method is known as 'progressive drawdown' or progress payments. However, you still need to come up with a deposit yourself.

Construction loans can be a more appropriate loan to take out when building a house from scratch or when doing a major renovation, and you might not get approved for a standard home loan otherwise.

How does a construction loan work?

Construction loans function very differently from a standard home loan. They typically charge interest-only repayments during the building process.

The interest-only period ensures your repayments are kept at a minimum during construction before reverting to a standard principal and interest mortgage after construction.

Once your construction loan gets the tick of approval, the lender can then make payments to your builder during each stage of building your house . The builder will outline the amount needed to construct your home, dividing the expected costs into segments. 
Varying between lenders, the progressive drawdown process will usually look a little something like this:
Stage What it includes
Deposit Pay the builder to begin construction.
Slab down or base Covers the foundation of your property: levelling the ground, plumbing and waterproofing the foundation.
Frame Build the frame of your property. This often covers partial brickwork, roofing, trusses and windows.
Lockup Put up the external walls and put in windows and doors.
Fitout or fixing This often covers the cost of internal fittings and fixtures, like plasterboards, part-installation of cupboards and benches, plumbing, electricity and gutters.
Completion Covers the conclusion of contracted items (like builders and equipment) and any finishing touches like electricity, plumbing and overall cleaning. 

Lenders will send a valuer to check the work has been completed at each stage of the construction process before releasing the next payment. 

Funds from your approved loan amount are only charged interest as they are paid to the builder (as they are drawn down). So if one stage costs $50,000, you'll only be charged interest on that $50,000 for the duration of that stage. But if you draw down an extra $50,000 to pay the builder for the next stage, your repayment will now be based on the interest on that $100,000.

A construction loan can be used for big structural renovations too (like extending the house or adding on a deck) but not for smaller cosmetic renovations (like updating the kitchen and bathrooms).

Risks of construction loans 

Construction loans aren't without disadvantages or risk. They tend to have higher interest rates than standard home loans as it's harder for a lender to value a home that doesn't exist yet. The same applies to fees, especially valuation fees.

Constructing a property, in general, can be risky, as there's no guarantee of whether the build will be completed on time or whether it will go over budget. The final value of the house can also differ from what you initially expected.

The right construction loan can help minimise these potential risks, however.

Can you use the equity in your home for a construction loan?

Yes, one way to fund your construction loan is to use any equity you have in an existing property. Equity is a powerful tool for homeowners to use, and as long as you have enough equity to meet the loan's deposit requirements (which will often be at least 20%, but sometimes more), you can get a construction loan this way. 

Can you use the equity in your land? 

You can still technically use the equity you have in a vacant piece of land to fund a construction loan, as land can still increase in value just as a home can. Whether you can use it to build on the same property will be a matter for your lender to discuss with you. 

If you're planning on just buying vacant land, a vacant land loan is a separate product from a construction loan. With construction loans you'll have a set timeframe to construct a home on the land.

How to get a construction loan

Applying for a construction loan is a bit different to applying for a regular home loan on an existing property. In addition to all the usual documents needed for a home loan application, you may need to provide the following when applying for a construction loan:

  • Council plans and permits
  • Professional building plans
  • Proof of land purchase
  • A contract with a licensed builder 
  • Proof of builder's insurance

If you need additional work for things like a swimming pool, sheds, etc you will need to provide quotes for these to the lender.

How do you qualify for a construction loan? 

The lender may then send someone out to give a valuation of the to-be-completed home. Once the lender has received this valuation, they may give you authority to proceed by approving you for a construction loan.

After this, the normal qualifying process for a home loan follows, and you'll need to make a deposit on the property as you would with a standard home loan. This means you'll still need:

  • To demonstrate good savings behaviour 
  • A good credit rating
  • To meet the lender's deposit requirements 
  • And prove you can repay the loan over time 

It's important that when you apply for a construction loan that the building contract is final and has all the required details including the construction stages, progress payment schedule and other building costs. Even small changes may require the lender to reassess your application. 

Our construction loan approval process

Step 1: Application

Lodge an application online at or arrange a call with a lender through our online booking form

Step 2: Talk with a Lender

Talk with one of our lending managers. They will help you choose the most appropriate loan for your needs, determine what size of loan you could afford to service, and arrange a conditional-approval. If you haven’t filled out an application yet, our lender will fill it out while talking with you and submit it on your behalf.

Step 3: Upload Documents

You upload your supporting loan documents to onTrack, our easy to use online portal and synchronised mobile app. OnTrack is a groundbreaking system that lets you complete your home loan application entirely on your mobile device or computer from initial contact through to settlement and registration for online services.

You will need:

  • two pay slips
  • three months of statements for your salary account
  • evidence that you have your deposit
  • A contract of sale for the land (or proof that you own it)
  • a fixed price building contract from a registered builder

We will then contact your builder and arrange a property valuation.

Step 4: Final Approval

At this Stage you will receive through onTrack:

  • Final Approval of your loan
  • Your Mortgage documents and Loan Agreement pack

Step 6: Settle the land

If you don’t already own the land, we will fund its acquisition from the vendor.

Step 7: Fund Construction

Now we start to pay for each stage as it is completed. As each stage is finished, we arrange a progressive inspection and then, if everything is in order, we pay the builder directly in accordance with the progressive drawdown stages outlined above. 

Step 8: Move in

When the home is completed, you will receive an Occupancy Permit from the local council to say that you are allowed to live in it. Congratulations! You now own a completed home! It is time to collect the keys and move in, or find a tenant if it is an investment property.

Step 9: Maintain your loan

Once your home is complete and the final payment is made, your home loan will now revert to an Offset variable loan. You may order a visa debit card if you wish to have one linked to your offset account.

Talk to our lending specialists today's construction loan is perfect if you plan to buy land and construct a home or if you're completing extensive renovations to your existing property.

Our building loan offers a competitive interest rate that converts to our market-leading Offset variable home loan once the construction of your new home is complete.

To find out more, get in touch with one of our home loan specialists.

About the article

As Australia's leading online lender, has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.

Tags: building a home construction loan