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Getting A Loan To Build A House

Mortgage Warehouse mortgage brokers have been arranging construction loans since 1999.

Building a house can be a stressful and busy task.  Regardless of how you get your home built, there is a lot to think about and a lot to do. 

It is important to have the finance organised so you can ensure that your house is built to plan and within budget. 

 

Introduction

The trick with loans to build is that the lender's security 'develops' as the house is being built.  Compare this to a fully completed house where the lender's mortgage that secures its loan, is registered over a completed and saleable dwelling.  

With a construction loan, initially a lender's security will probably be a bare-land section.  When construction begins the lender's security is enhanced by the ongoing development of the land, but the risk to the lender is that the construction is not completed, leaving it with a section and partially completed house as security for its loan.  This outcome is much less desirable for a lender than the common scenario where its loan is secured by a house which is readily saleable.  

While a house is under construction the lender carries an increased level of risk because if, for any reason, construction is not completed it could be left with a half-finished project as security for its loan.  So, lenders are naturally very careful to ensure that their loan is well secured during the construction phase and that sufficient funding is available to complete the construction as planned.  Anything less is unsatisfactory for both parties. 

 

Some common methods of contracting the build

There are various methods of contracting someone to build your home and below are some common examples.

Self managed labour-only contract 

  • You get the house designed, the plans drawn and specifications prepared.  These documents must be satisfactory for council purposes and for you to manage the process.  You organise the necessary local authority consents. 
  • You arrange for all the quotes to build the house, you sign up labour only contracts with builders, plumbers, electricians etc to do the work.  You purchase the materials and organise and co-ordinate everything from delivery of materials, insurance during construction, council inspections etc.
  • Labour-only contracts may be suitable for project managers who have experience in the building industry.  If you don't have the necessary experience, the risk of delays, cost over-runs, and "something" being forgotten is high. 

 

Fixed-price contract

  • A builder or building company enters in to a fixed-price contract to build a house based on plans and specifications which (normally) have been approved by council, or are acceptable for building consent purposes. 
  • A fixed-price contract need not cover everything (eg driveway, landscaping, carpets, curtains etc) but usually includes all the labour cost for all contractors involved (plumbers, electricians, painters etc), cost of materials, builders risk insurance, and contingencies. 
  • Fixed-price contracts have the benefit of clearly identifying what is (and by extension what is not) included in the price.  This means you can budget for the other items which are not included in the fixed-price aspect of building your house. 

 

Turn-key contract

  • A turn-key contract will have a fixed-price to build or install almost everything, so that when the construction is finished, you can "turn the key" and move in.  A turn-key contract usually covers the construction, appliances, painting, landscaping, curtains and floor coverings, and even your letter-box. 
  • There should be no surprises with a turn-key contract.  Everything that you have planned should be included and delivered in terms of the contract, which makes life easier for the lender too.  

 

LVR guidelinesLabour-onlyFixed-priceTurn-key
 Typical Loan to Value Ratio  65%  80%  80%
     

 

Progress payments for the builder

It is important that your finance is sufficient to pay for the entire construction, including contingencies, and is scheduled to be drawn down in stages to pay for the construction as it reaches its various milestones.  This process needs to be clearly understood at the outset because it can be stressful if your builder expects payment for work before the lender has schedule its draw down.  This is some of the detail that we handle for you. 

The table below is one example of how a progressive draw down schedule might be arranged. 

Construction stageExample draw down
 Deposit  10%
 Foundations  10%
 Floor, framing & roof  20%
 Lock-up  25%
 Internal lining and doors  25%
 Completion  10%

 

Progressive valuation reports

The need for progressive valuations depends on several things, including the lenders LVR and the nature of the contract to build. 

It probably isn't helpful to outline the myriad of different situations here, suffice to say that a valuation report will most likely be required and we will discuss this aspect with you when the finance is being arranged. 

 

The golden rule

LVR calculations are always based on the lesser of cost or value. 

Generally in a construction scenario value will exceed cost so the calculations are most frequently based on the cost price.  If value is less than cost, the calculations will be based on the value. 

If the maximum LVR is 80% (and assuming cost is less than value), the lender will effectively fund 80% of the cost of the project.  The balance of the cost must be funded by you. 

 

Here is an example of how a construction loan might work for you

This example is intended to demonstrate the concept.  Most situations are unique so we plan each transaction carefully from the outset.

The key variables here are as follows.

  • Land costs $180,000.
  • You have $130,000 and need to borrow $50,000 to buy the land.
  • A fixed price cost to build is $320,000, so you will owe $370,000 on completion.
  • The total project will have cost $500,000 represented by the section cost of $180,000 and the build cost of $320,000.

 

StageStage
Cost
Stage
Loan
Total
Loan
Property
Cost
LVR on
Cost
Property
Value
LVR on
Value
Equity
 Land only  $180,000  $50,000  $50,000  $180,000  27.8%  $180,000  27.8%  $130,000
 Deposit  $32,000  $32,000  $82,000  $212,000  38.7%  $180,000  45.6%  $98,000
 Foundation  $32,000  $32,000  $114,000  $244,000  46.7%  $240,000  47.5%  $126,000
 Walls & roof framing  $64,000  $64,000  $178,000  $308,000  57.8%  $295,000  60.3%  $117,000
 Closed in  $80,000  $80,000  $258,000  $388,000  66.5%  $380,000  67.9%  $122,000
 Interior wall linings  $80,000  $80,000  $338,000  $468,000  72.2%  $470,000  71.9%  $132,000
 Final payment  $32,000  $32,000  $370,000  $500,000  74.0%  $550,000  67.3%  $180,000

 

Focus on the big job

It is very important to have the right funding for the job and your time is best spent making sure that the construction goes to plan and that you get what you are paying for, in terms of the plans and specifications for your house.

The finance can be taken care of.

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