Beginner's Guide to Construction Loan Structures

A construction loan pays out in stages as your build progresses, and interest is charged only on the amount drawn so far. For a tradesperson planning a build, the structure of that loan matters as much as the lender you pick.

You already understand how a job runs in stages. A construction loan works the same way. The money follows the work, and each release has to be justified by a completed stage.

How Does a Construction Loan Work?

A construction loan releases funds to your builder in stages as each part of the build is finished, rather than as one lump sum. Interest is normally charged only on the amount drawn down, so early repayments are small and rise as the build advances.

The lender first assesses your construction loan application against the building contract, the council plans and your income. Once the build starts, each stage is paid on a progress payment schedule. After the build is complete, the loan usually moves to a standard repayment arrangement. This is often called a construction to permanent loan.

The trade-off is that you carry the cost and responsibility of a loan that grows over time. Delays extend the period you are paying interest on drawn funds.

What Is a Progress Payment Schedule?

A progress payment schedule is the list of build stages and the portion of the loan released at each one. Common stages include slab, frame, lock-up, fixing and completion, though your contract sets the exact breakdown.

Before each payment, the lender usually arranges a progress inspection to confirm the stage is finished. Some lenders charge a Progressive Drawing Fee for each release, so ask about this cost early. It is a small cost per draw, but it adds up over a build with several stages.

Lenders release funds against their own approved schedule, so confirm it lines up with your building contract before you sign. Payment timing affects the builder's own cash flow, including the plumbers, electricians and other sub-contractors they need to pay.

Fixed Price Building Contract or Cost Plus Contract?

A fixed price building contract sets the total cost up front, while a cost plus contract charges actual costs plus a margin. Lenders generally find fixed price contracts easier to assess because the loan amount is known from the start.

A cost plus contract can suit complex or custom designs where the final cost is hard to pin down. The risk is that the total can rise during the build, and your loan may not cover the extra. Many lenders, including most major banks, will not fund a loan against a cost plus contract. A few lenders accept it with conditions such as a hard cap on the funded amount or more equity. Confirm that your lender accepts the contract type before you sign the building contract, because finding out afterwards can derail the project.

A fixed price contract has its own trade-off. Variations and changes you request later can still add to the cost, and you may need to fund those from your own savings.

Example: A Carpenter Building on Land He Already Owns

Consider a carpenter who owns a block outright and wants to build a family home with a registered builder on a fixed price contract. His income is steady but he is worried about cash flow during the build.

The contract is split into five stages. His broker arranges a loan where the land counts towards his equity, so little or no cash deposit may be needed depending on the lender and the valuation. During the build he pays interest only on the funds drawn, as the stages are signed off.

As an illustration at 6.75% p.a., if $200,000 has been drawn at the halfway point, the interest-only repayment is about $1,125 a month ($200,000 x 6.75% / 12). That rises as later stages are paid. At the end of the build, the loan converts to principal and interest. Because he understood the schedule from the start, he kept a cash buffer for variations and was not caught short when a late change added cost.

This rate is an example only. Your actual rate will depend on your deposit, your lender and your loan structure.

Land and Construction Package or Land and Build Loan

A land and construction package ties the land purchase and the build together under one loan, while a land and build loan may be arranged around separate contracts. The right fit depends on whether you are buying land and a builder together or sourcing them separately.

With a package, the land is usually settled first and the build is then paid in stages. You pay interest on the land from settlement, so the timeline between settlement and build start affects your costs. Council approval and any development application must also be in place before most lenders release funds for the build.

If you are buying your first property, see how this works for first home buyers. Lenders set their own time limits for starting and finishing the build, such as how long a loan approval stays valid, so ask your lender for these dates in writing.

Owner Builder Finance: What Changes for Tradies

Owner builder finance is harder to get than finance with a registered builder, because the lender takes on more risk. Being a tradesperson does not automatically qualify you, and many lenders will want to see licences, experience and a detailed budget.

Lenders often limit the loan amount, ask for a larger deposit, or restrict which lenders will consider the application. State rules on owner builders and permits also apply, so check your local requirements. The trade-off is that you carry the full risk of cost blowouts and delays, and you pay sub-contractors on your own schedule while the lender releases funds only on approved stages.

Because policies vary, working with a broker who can access construction loan options from banks and lenders across Australia saves you from approaching lenders one at a time.

Which Repayment Structure Suits Your Build?

Interest-only repayments during construction are the most common structure, because the balance rises as funds are drawn. Principal and interest then starts once the build is complete.

The cost of this structure is that you are not reducing the loan balance during construction, so the full amount remains to be repaid afterwards. The right loan structure depends on the project, the lender and your equity, so it helps to compare your options with a home loan specialist.

Use a repayment calculator to test different draw amounts before you commit. A buffer for interest and unexpected costs protects you if the build runs late.

MJ Finance and Advisory can map out the structure that fits your contract, your cash flow and your timeline. Call one of our team or book an appointment at a time that works for you.

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