Using your equity in land for a construction loan

If your ‘Great Australian Dream’ is to build a home from scratch, it could make sense to use the equity in your block of land to start building.

Refinancing your current home loan to unlock the equity in your home could be a good way to purchase your next property, but did you know you can also do something similar for land and building your home? Such a home building and finance tactic is called a ‘land equity construction loan’.

Can you use equity in land to finance a construction loan?

The short answer is yes. Refinancing to a construction loan can be a great way to get a competitive new interest rate, while also unlocking how much your land value has appreciated over the years.

Equity is essentially how much your land has appreciated in value, plus how much you’ve paid into the loan, minus how much you still owe on the land loan. if your land is worth $500,000, and you still owe $300,000, your equity is $200,000. If the contract to build is worth another $500,000, the total valuation will then be $1 million.

From there you can consider the $200,000 you’ve built up in equity as your deposit. $200,000 is 20% of $1 million, which means you can then take out a loan without paying lenders mortgage insurance (LMI), and you also won’t need any additional funds for the loan.

Pros and Cons of Land Equity Construction Loans

Before diving in, there are a few things you should know before you refinance your land loan for the purpose of funding a construction loan.

Pros

• It’s effectively a time saving device: Rather than putting money into a savings account to build up a deposit on a construction loan, you can refinance to use the equity in your current land loan, which can save a lot of time.

• It’s convenient: Usually the next logical step after buying land is to build a home on it. In Australia, it’s usually the land that makes up most of the overall property’s value performance, and not the dwelling itself. So, if you’ve held your land for a while, it could be worth a lot more than when you first bought it, depending of course on many factors including location, type and size of block, and so on.

Cons

• You’re now potentially paying off a much larger loan: It is possible to over-leverage yourself here, so it’s helpful to use a mortgage calculator to find out how the construction loan fits into your budget.

• Land valuation: Lenders will use the valuation figure of the land value, as well as the cost of construction as the total purchase value. This could be higher or lower than you were thinking, likely depending on how long you’ve held your land for. Believe it or not, land values can go backwards.

How much can you borrow on a construction loan?

A construction loan is slightly different to a regular home loan. It could be anywhere from a few hundred thousand dollars, to a million dollars. loans.com.au lends money at various stages of the construction process, paying interest-only while construction is in process:

1. Deposit (e.g. equity unlocked and refinanced from land loan)

2. Slab built

3. Frame up and complete

4. Lock-up (e.g. external walls, windows, and doors)

5. Fixtures (e.g. tabs, plumbing and so on)

6. Virtual completion of the home

Before all that though, you’ll need to find a licensed builder, and get builders' insurance, a building plan, and building contracts written up.

What’s the difference between a land loan and a construction loan?

The difference is pretty simple. A land loan is accessed for a vacant block, whereas a construction loan is specifically for the purpose of building a new home. A construction loan is the one you’ll need to actually start building a home to live in. Construction loans also usually have a maximum building commence time, usually six months.

If you’re ready to start your home construction journey, speak with one of our lending specialists today to talk about refinancing.