Plenty of people on the Northern Beaches and the lower North Shore look at the price of a renovated house next door, then look at their own tired 1960s place on a good block, and start wondering about a knockdown rebuild. The numbers can make sense. The finance is where it gets fiddly, because a construction loan is not just a bigger version of a normal home loan.
How a construction loan pays out
With a standard loan the full amount lands in one go. With a construction loan the lender releases money in stages as the build moves along. These are called progress payments or drawdowns, and they are tied to the milestones in your building contract. The exact stages vary by builder and contract, but they usually follow the build: slab, frame, lock-up, fixing, and completion.
Before each payment the lender normally wants an invoice from the builder and often an inspection or valuer's sign-off that the work is actually done. That protects you as well as them. It also means the money moves on the builder's timetable, not yours.
You only pay interest on what has been drawn
During the build, interest is generally charged only on the amount that has been paid out so far, not the whole approved limit. In the early months your repayments are small and they climb as each stage is drawn. Many lenders offer interest-only repayments for the construction period, then the loan moves to a normal repayment structure once the build is finished. Check the terms of the particular loan, because they differ.
What lenders want to see before they approve
- A fixed-price building contract with a licensed builder. Lenders are far more comfortable with a fixed price than a cost-plus arrangement.
- Council approval. Plans, and the development approval or complying development certificate, so they know the build can go ahead.
- Builder details and insurance. Home warranty insurance and builder's cover are part of what they check.
- A valuation on the finished product. The lender values the property as it will be once complete, based on the plans, and lends against that figure.
- Your usual borrowing evidence: income, expenses, debts and savings, the same as any other home loan.
Owner-builder projects are a harder sell. Many lenders will not touch them, and the ones that do tend to ask for more evidence and a larger buffer.
Where the deposit and the existing home fit in
If you already own the house you are about to knock down, the land and the equity in it often act as your deposit. That is a big advantage over buying a block and building from scratch. What the lender needs is a clear picture of the whole project: what you owe now, the land value, the build cost, and what the finished property should be worth.
If you want to see how much equity you could draw on, our page on equity release explains how that works.
Where people get caught
- Where you will live. You cannot live in the house while it is being demolished and rebuilt. Rent or a temporary stay is a real cost that sits on top of the build, and it can run longer than planned. If you are buying before selling, our guide to bridging finance covers a related problem.
- Variations and overruns. Changes to the plans, soil surprises on a sloping block, and price rises on materials can all push the cost above the contract. Lenders do not automatically lift your limit. A contingency buffer is worth building in from day one.
- Delays. Construction loans usually have a time limit. If the build drags, you may need the lender to agree to an extension.
- The existing loan. If you have a mortgage on the property now, it normally gets rolled into the construction facility or refinanced with it. Break costs on a fixed rate can apply, so check before you start.
What happens when the build finishes
Once the house reaches practical completion and you have the paperwork, the loan converts to a standard home loan. This is a good time to look at the rate and features again, since you are no longer locked into a lender chosen for its construction product. Our article on when to refinance goes through what to check.
Talk to someone before you sign the building contract
Get the finance looked at early, before you sign with a builder, not after. The structure of the loan can change what you can afford to build, and a lender's requirements sometimes affect which contract terms work. If you want to talk it through, get in touch or call 1300 001 755. We are licensed credit advisers in Forestville and work with clients across the Northern Beaches and North Shore.
Frequently asked questions
How does a construction loan work?
The lender pays out the loan in stages as each part of the build is completed, usually against builder invoices and sometimes an inspection. Interest is generally charged only on the amount drawn so far.
Can I use the equity in my current home for a knockdown rebuild?
Often, yes. If you own the property you are demolishing, the land and the equity in it can act as your deposit. The lender looks at the whole project, including the value of the finished home.
Do I need a fixed-price contract to get a construction loan?
Most lenders prefer one and some require it. A fixed-price contract with a licensed builder gives them certainty about the final cost.
Can I get a construction loan as an owner-builder?
Some lenders will consider it, but many will not. Those that do usually ask for more evidence and a bigger buffer.
What happens to my loan when the build is finished?
It converts to a standard home loan, typically with principal and interest repayments. It is a good point to review the rate and features.
General information only. It does not take your objectives, financial situation or needs into account, and it is not credit or financial advice. Lender policy, rates and eligibility change regularly and vary between lenders — talk to us about your own circumstances before acting on anything here.