What is Construction Loan?
A construction loan is one set up for the purpose of building a new home or substantially renovating an existing home where structural renovations are required. A construction loan is drawn down in stages called progress payments.
Construction loan is very different from a standard home loan, primarily due to the fact that the lender only has security over the land whilst they are asked to fund the end value of
house and land.
In order to limit their risk the lenders do partial drawdowns of the agreed total loan and pay the builders normally over five stages of the construction as each phase is completed.
The borrower is only charged interest on the portion of the loan that has been drawn down. The construction loan is set as an interest only loan during the construction and on completion of the building the lender converts the construction loan to a normal principal and interest loan.
What is Progress payment?
A progress payment refers to each payment made to your builder according to a fixed price building contract. This means your loan is funded in stages.
Potential cashflow challenges whilst building
One of the biggest challenges to building is having to fund the existing mortgage whilst paying for the new loan on the building loan. Progressive interest only payments during construction will help your cashflow a little but you will need to be careful with your budget if your finances are tight because builders notoriously take longer than planned. Ask your mortgage broker if you can have your existing loan changed to reduce your repayments to the absolute minimum by converting your existing loan to interest only or possibly extending the term.