Quick Answer
A construction loan releases funds in stages as your build progresses rather than as a single lump sum. You only pay interest on the amount drawn down so far. Most lenders require a fixed-price building contract, council-approved plans and a registered builder. The loan is interest-only during the construction period (typically 12 to 24 months), then converts to a standard principal and interest home loan once the build is complete.
Because you only pay interest on the amount drawn down, your repayments start low and increase gradually as each progress draw is released. This keeps your costs manageable during the build when you may also be paying rent or an existing mortgage.
How Construction Loans Work
A construction loan is structured differently from a standard home loan. Rather than borrowing the full amount upfront, the loan is drawn down in stages that match the construction milestones in your building contract.
Step 1: Land purchase (if applicable). If you are buying land and building, the first drawdown covers the land purchase. You begin paying interest on this amount immediately. If you already own the land, this step is skipped.
Step 2: Construction begins. Once your builder commences work, they will invoice at each progress milestone. You (or your broker) submit the invoice to the lender along with a progress inspection report.
Step 3: Progress draws. The lender releases funds directly to the builder at each stage after verifying the work has been completed. A valuer or inspector confirms the stage is complete before each draw is approved.
Step 4: Practical completion. When the build is finished, a final inspection confirms everything is complete. The remaining funds are released to the builder.
Step 5: Loan converts to P&I. After practical completion, the construction loan converts to a standard principal and interest home loan. Your repayments increase because you are now repaying both the principal and the interest on the full loan amount.
Progress Draw Process
Progress draws are the stages at which the lender releases funds to your builder. Most construction loans involve 5 to 6 draws, aligned with standard building milestones.
| Stage | Typical % of Contract | What Is Completed |
|---|---|---|
| Base / Slab | 10% to 15% | Site preparation, footings, concrete slab poured |
| Frame | 15% to 20% | Wall frames erected, roof trusses installed |
| Lock-up / Enclosed | 20% to 25% | External walls, windows, doors, roof completed |
| Fit-out / Fixing | 20% to 25% | Internal walls, plumbing, electrical, cabinetry, tiling |
| Practical Completion | 5% to 10% | Painting, final fixtures, landscaping, handover |
Percentages are indicative and depend on your specific building contract. Some contracts include a sixth stage (deposit to builder) of 5% paid before construction begins.
At each stage, your builder submits an invoice. The lender arranges a progress inspection (usually by an independent valuer) to confirm the work has been completed to the invoiced stage. Once confirmed, the funds are released directly to the builder, typically within 5 to 7 business days.
You cannot draw down more than the value of work completed. If a builder invoices for the frame stage but only half the framing is done, the lender will not release the full frame draw. This protects you from paying for work that has not been finished.
Costs During Construction
Understanding the costs during the construction period helps you budget accurately and avoid surprises.
Interest-only repayments. During construction, you only pay interest on the amount drawn down. After the slab draw of $50,000, your monthly interest at 6.50% is approximately $271. After the frame draw brings the total to $120,000, your monthly interest rises to approximately $650. By practical completion, you are paying interest on the full loan amount.
| After Stage | Cumulative Drawn | Monthly Interest (at 6.50%) |
|---|---|---|
| Land purchase | $350,000 | $1,896 |
| Base / Slab | $400,000 | $2,167 |
| Frame | $470,000 | $2,546 |
| Lock-up | $550,000 | $2,979 |
| Fit-out | $630,000 | $3,413 |
| Practical completion | $680,000 | $3,683 |
Example based on $350,000 land and $330,000 construction contract at 6.50% interest. Your figures will vary.
Progress inspection fees. Lenders charge a fee for each progress inspection, typically $150 to $350 per inspection. Over 5 to 6 draws, this adds $750 to $2,100 to your total costs.
Council fees and permits. Building permits, development applications and any required certifications are payable before or during the build. These are separate from the construction loan.
Builder's deposit. Some builders require a 5% deposit before commencing work. This is usually paid from your own funds, separate from the loan.
Builder Requirements
Lenders have specific requirements for the builder you use. These protect both you and the lender against construction risk.
Registered and licensed. Your builder must hold a current builder's licence in the relevant state or territory. Lenders verify this as part of the approval process.
Fixed-price contract. Almost all lenders require a fixed-price building contract. This means the total cost of the build is agreed upfront and cannot increase unless you approve a variation in writing. Cost-plus contracts (where you pay actual costs plus a margin) are rarely accepted by lenders.
Builder's insurance. Your builder must hold current public liability insurance and domestic building insurance (also called builder's warranty insurance or home warranty insurance). This protects you if the builder becomes insolvent or fails to complete the work.
Council-approved plans. Full council approval (or a complying development certificate) for the build must be obtained before the construction loan can be drawn down.
HIA or MBA membership. While not mandatory for all lenders, membership of the Housing Industry Association (HIA) or Master Builders Australia (MBA) provides additional assurance of the builder's credentials.
Owner-Builder Loans
An owner-builder manages the construction themselves, hiring subcontractors directly rather than engaging a registered builder. This can save money but makes financing significantly harder.
Limited lenders. Most major banks do not offer construction loans to owner-builders. You will need to use a specialist or non-bank lender, of which there are relatively few.
Lower LVR. Owner-builder construction loans typically cap at 50% to 60% LVR. This means you need substantial equity in the land or a large deposit to cover the gap.
Higher rates. Expect rates 0.5% to 1.5% above standard construction loan rates. Lenders view owner-builder projects as higher risk due to the lack of a licensed builder managing the project.
Owner-builder permit. You will need an owner-builder permit from your state or territory authority. In most states, this requires completing an approved owner-builder course, which typically takes 1 to 2 days.
Quantity surveyor report. Most lenders require a quantity surveyor's report confirming the build cost estimates are realistic. This is an additional cost of $1,000 to $3,000.
Additional inspections. Lenders may require more frequent progress inspections for owner-builder projects, adding to the inspection fees.
Land and Construction Packages
If you are buying land and building, you have two main options for structuring the finance.
Combined land and construction loan. A single loan covers both the land purchase and the construction. The land portion is drawn down at settlement, and the construction portion is drawn in stages as the build progresses. This is the most common approach and is simpler to manage.
Separate land loan and construction loan. You take out a separate loan for the land purchase and a separate construction loan for the build. This can sometimes offer more flexibility (for example, if you want to buy land now and build later), but involves two sets of fees and two applications.
House and land packages. Some developers offer house and land packages where the land and building contract are bundled together. These can simplify the process, but you should compare the total cost against buying land and engaging a builder independently.
If you buy land with the intention of building later, be aware that some lenders require construction to commence within 6 to 12 months of the land purchase. If you delay beyond this, the lender may reassess or reclassify the loan. Discuss your timeline with your broker upfront.
Planning to Build? Talk to a Broker First
Construction loans are more complex than standard home loans. A licensed broker can help you choose the right lender, structure the loan correctly and guide you through the progress draw process, at no cost to you.
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