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Construction numbers are continuing to increase as many home buyers and investors are looking for a better way to purchase their own home or expand their portfolio.

Construction numbers are continuing to increase throughout Australia as many home buyers and investors are looking for a better way to purchase their own home or expand their portfolio.

According to the Australian Bureau of Statistics, owner occupied construction commitments have been continually rising for the past 18 months up to May 2014. There has also been an increase of over 20% for the value of construction loans over the past two years. This shows that more Australians are choosing to either build or renovate their property rather than buying already built homes. 

If you wish to build your own home or upgrade the property you live in now, there is a home loan option to suit your situation specifically and that is called a construction loan. 

When constructing a new home or completing a major renovation on an already built home, your finance needs will be a little different in the initial stages. A construction loan is a specialised finance option for building or major renovations which is designed for the building process.

At the start the lender will use the plans and specifications to give the property a value when it is completed. These are usually conservative and will generally be the cost of the land plus the cost of construction. The valuer will then “sanity” check this figure to ensure that properties can be sold for at least this amount. 

The lender will then base the lending amount on the completed value amount. For example if you purchased the land for $150,000 and construction costs amount to $200,000, then the value will be around $350,000. If you need to borrow $280,000 for this, then it is an 80% lend ($280,000/$380,000).

With a regular purchase, the lender will put in the loan amount at settlement, however, with a construction loan, progress payments are made by the lender periodically throughout the construction stages. 

Most lenders will organise to have the property checked and valued after each stage has been completed to ensure it is at an acceptable standard and the work for the stage has been completed before they issue the next payment. This protects you and the lender if the builder is not completing each stage as set out in the contract.

Each progress payment is called a draw down, and interest is only charged on the amount drawn down at the time interest is calculated. So, if you have approval for a $250,000 loan but have only drawn down $80,000 – you’ll only be charged interest on that $80,000 until you make further draw downs.

One of the positives about using a construction loan is that repayments are usually interest only during the construction phase. This can help reduce the stress most people experience when building their own home. Also, interest will only be charged on the amount that is ‘drawn down’. So, if you have taken out a $300,000 home loan, but have only used $50,000, you will only be charged interest on that amount until you drawn down more. 

Some of the other benefits include: 

• Progress payments: By paying throughout the construction process, you are ensuring that the builders complete every stage properly before they receive their next payment. 

• Interest reduced: With construction loans, you are only changed interest on the amounts you have drawn, not the full loan amount, which can save you a significant amount of money during the building period. 

• Smaller repayments: As you are paying interest only during the building period, your repayments will be significantly lower, which can help ease the financial burden during this time. 

Some of the pitfalls include: 

• More paperwork upfront: Before a lender can approve a construction loan, they will need to see the council approved building plans and the building contract.

• Funds for the finishing touches: When construction is complete you will still need to budget for costs to get it liveable. Depending on what is included in the contract, you may still have to pay for driveways, landscaping, fly screens, floor coverings, landscaping and fences. 

• Budgeting for rent and loan repayments: Even though the loan repayments will only be on what is drawn down, these will have to be paid while you are also paying rent until the property is completed. Due to this some people choose to move back in with parents during construction to ease the pressure on the budget.

• Over committing: A home that starts out quite cheap can quickly increase in cost when making selections and making changes to the basic plan. Ensure that you do the sums upfront as to what you can afford. If you haven’t got much surplus cash and are not good at budgeting and estimating costs, you may be better off buying a completed home where the full costs is known upfront.

Before going ahead with a construction, speak with different lenders about what options are available and carefully research which option will be the best choice for you.