Planning to build your own home from scratch? The mortgage market is flooded with different kinds of home loans and in case you plan to build your own home, a traditional home loan may not be the best option for you. Many lenders offer special land and construction loans that are tailor made for borrowers constructing their own home and can help you save significantly over the life of the loan.
What is a land and construction loan?
A land and construction loan is a specially designed product offering progressive payments in line with different stages of construction. Interest is generally charged only on the amount drawn down, which means you are only paying interest on the part of the loan you are actually using.
When building a home, you do not need the full amount at one go. A construction loan allows you to drawdown progressive payments according to the stages of construction. There are five stages of construction that are usually considered:
Purchasing the land
Roof (including frames)
Once a stage of construction is completed, you can request the next drawdown. A valuer will check the property to ensure the work has been completed according to the specifications in the building contract before the lender approves the next drawdown. This scores a double whammy for the borrower – low interest (as it is only calculated on the amount withdrawn instead of the full approved amount) and a valuer double checking the quality of work done by the builder.
How to apply for a land and construction loan?
Before you apply for a land and construction loan, it is important to zero down on a builder, as a signed building contract with an approved builder is pre-requisite for having your construction loan approved. Usually, lenders will let you borrow up to 60-65% of the total cost but being backed by a parental guarantee you can borrow up to 100% of the total cost. However, it is always best to have some savings for any unforeseen expenses. You can also consider a small line of credit to meet additional expenses during the process of construction.
Apart from the regular documents you need to apply for a home loan, the following documents are a must before you apply for a land and construction loan:
1. Council approved building plan
2. Signed building contract with an approved builder
3. Copy of builder’s license and insurance policy
4. Quotes for additional works you may need to pay for such as landscaping
The lender will take into account the cost of the land as well as the construction costs to determine the loan amount. A valuer will assess the on-completion value of the house and the lender will take into account the lesser of the land value and construction costs and the on-completion value of the house for approving the loan amount.
Advantages of a construction loan over a standard home loan:
1. Save interest – As the loan is usually drawn down in five installments, interest is only calculated on the amount withdrawn instead of the full approved amount meaning you only pay for what you use.
2. Lower repayments – A land and construction loan is interest only till the construction is completed in full and interest is only payable on the amount used. Event though the interest rate may be slightly higher than the standard variable home loan interest rate, the repayments turn out to be much lesser in the construction phase giving you extra cash at disposal to meet any urgent expenses.
3. Better borrowing capacity – With a land and construction loan, a borrower is able to borrow money according to the completed value of the house instead of its current value – a big plus over standard home loans that are calculated on the existing market value of the property.
Some tips to keep in mind:
1. First Home Owners Grant (FHOG) – Many States offer incentives to first home owners and those constructing on vacant land. Have you checked your eligibility for a State grant?
2. Finance clause – Having a finance clause inserted in your building contract can help you buy time for seeking suitable finance by taking the land off the market for a stipulated period.
3. Quote for additional work – Including quotes for additional work such as landscaping, construction of swimming and other such works in your building contract can ensure you have finance handy for these home improvements, as making iterations in the building contract after the loan is approved may require you to apply for the loan all over again.
4. Contact an expert – Getting in touch with an expert mortgage broker can save you tons of money and time and help you find the most suitable home loan for your requirement by helping you steer deftly through the highly competitive mortgage market. Brokers at HashChing are will answer all your home loan queries online, absolutely free of cost.
By Vidhu Bajaj