Construction Loans: Everything Builders and Investors Need to Know
- A construction loan is a specialised mortgage that releases funds progressively as building work is completed — not as a lump sum at settlement
- Interest is charged only on drawn funds during construction — your repayments are lower in the early stages and increase as more money is drawn
- Most construction loans revert to a standard variable rate home loan at the end of the building period
- The five standard progress payment stages are: slab/base, frame, lock-up, fixing, and practical completion
- Builder selection is critical — your lender will require a fixed-price contract from a registered builder; cost overruns above contract are your responsibility
- Construction period LMI applies at the same thresholds as standard loans — but is calculated on the total completed value, not just the land purchase
How a Construction Loan Works
When you purchase an established property, your lender releases the full loan amount at settlement. Construction is different — you don't receive the full loan upfront because the property doesn't yet exist in its complete form.
A construction loan releases funds in stages as building work progresses. You draw funds as each stage of construction is completed, up to the total approved loan amount. Interest is charged only on the funds you have drawn, not the full loan amount — this is called an "interest-only drawdown phase."
The Five Progress Payment Stages
Construction loans in Australia are structured around five standard building stages, each triggering a progress payment from the lender:
Stage 1: Slab / Base (15-20% of contract price) The foundation is poured. This is the first drawdown after land settlement.
Stage 2: Frame (15-20%) The structural frame of the building is complete. The shell of the house is visible.
Stage 3: Lock-Up (25-30%) The building is "locked up" — external walls, roof, windows, and doors are in place.
Stage 4: Fixing (20-25%) Internal work is progressing — electrical, plumbing, plastering, kitchen and bathroom fitting.
Stage 5: Practical Completion (Final Payment) Construction is complete. Final inspection confirms the build matches the approved plans and contract.
For each stage, your builder submits a progress payment claim, a lender-approved valuer may inspect the work, and the lender releases the corresponding draw to the builder.
Interest During Construction
During the construction period (Stage 1 to practical completion), you pay interest only on the amounts drawn. This means early repayments are low and increase progressively as more of the loan is drawn.
Progressive Interest Example Total construction loan: $500,000 (land already settled separately). Stage 1 draw: $75,000. Monthly interest at 6.4%: $400. After Stage 3 draw (total drawn $350,000): Monthly interest: $1,867. After final draw (total $500,000): Monthly interest: $2,667. Once construction completes and the loan reverts to P&I, full repayments begin.
Setting Up a Construction Loan
Step 1: Land Purchase (If Applicable)
If you are purchasing land to build on, your construction loan typically covers both the land purchase and the build. The land settlement occurs first, and construction draws follow.
Alternatively, if you already own the land, you can apply for a construction loan against that land to fund the build only.
Step 2: Building Contract and Plans
Your lender requires:
- A fixed-price building contract with a registered builder
- Approved building plans and council approval (development approval / building permit)
- Your builder's registration certificate and insurance documentation
Fixed-price contract requirement: Most lenders require a fixed-price contract, meaning the final cost cannot exceed what is stated in the contract. Cost variations and owner-initiated changes during construction can add to the final cost — these must be funded from your own resources if they exceed the contracted amount.
Step 3: Loan Assessment
The lender assesses the loan based on:
- The end value of the completed property (as assessed by their valuer) — not just the land value or construction cost
- Your income and serviceability (assessed at the full loan amount at the APRA buffer rate)
- Your deposit relative to the total project cost (land + build + costs)
Note: LMI thresholds apply to the completed property value. If your loan amount exceeds 80% of the completed value, LMI will apply.
Construction Loan Risks to Manage
Builder insolvency: If your builder becomes insolvent mid-construction, the project stalls and you have partially drawn funds against an incomplete property. Mitigation: use a builder who is covered by Home Warranty Insurance (mandatory for most residential builds), check the builder's history, and ensure the contract has appropriate milestones and protection clauses.
Building contract overruns: Fixed-price contracts reduce this risk but do not eliminate it. Variations (owner-requested changes) add to the contracted amount. Budget a 5-10% contingency for variations.
Construction delays: Building projects routinely run over time. Your construction loan has a fixed construction period (typically 12-24 months). If building extends beyond this, you may need to apply for an extension.
Valuation shortfall: If the lender's end-value appraisal comes in lower than the total project cost (land + build), your approved loan amount may be lower than you need, requiring you to contribute more equity.
Investment Property Construction
For investors building rather than buying, construction loans offer two specific advantages:
Depreciation maximisation: New builds offer the maximum depreciation benefit — full Division 43 capital works deductions from completion and full Division 40 plant and equipment deductions on all fittings. This is not available on established second-hand properties purchased after 2017.
New build grants: Most states offer first home owner grants (and some investment incentives) for new builds that are not available for established property purchases.
Construction vs House-and-Land Package
A house-and-land package involves purchasing land and a signed building contract simultaneously, usually from a developer. Funding a package typically involves two stages: land settlement (funded from savings/land component of the loan) and construction draws.
The process is identical to a standard construction loan but streamlined through the developer's preferred lender process. Using a mortgage broker rather than the developer's lender ensures you get the most competitive construction loan rate, not just the rate the developer receives a referral commission for.
Frequently Asked Questions
Can I act as my own builder (owner-builder)?
Yes, but the lending landscape is significantly more restricted. Most major lenders do not offer construction loans to owner-builders, citing quality and completion risk. Some specialist lenders do — typically requiring the owner-builder to have relevant trade qualifications and sufficient contingency funds. Owner-builder home warranty insurance requirements also differ by state.
What happens to my construction loan after completion?
Most construction loans automatically convert to a standard variable rate home loan at practical completion. Review the rate and features at this point — it is a natural trigger to compare and potentially refinance to a more competitive product.
Written by Luke Drake | Authorised Credit Representative (CRN: 565112) | Frontier Finance Co