How construction loans work
A construction loan is a specialist home loan designed to fund the building of a property rather than the purchase of an existing one. Unlike a standard mortgage where the full amount is advanced at settlement, a construction loan releases funds progressively as building milestones are reached.
During the construction period, interest is typically charged only on the funds drawn down, not the total approved loan amount. Once construction is complete, the loan usually converts to a standard principal and interest mortgage.
How interest works during construction
If your loan is approved for $600,000 but only $200,000 has been drawn at the third progress payment stage, you are paying interest on $200,000 only. This keeps repayments manageable during the build period when you may also be paying rent.
Progress payment stages
Most construction loans in NSW follow a standard five-stage progress payment schedule aligned with the building contract milestones. Each draw is made after an inspection confirms the stage is complete.
- Slab or base stage: Foundations laid, slab poured. Typically 10% to 15% of the contract price.
- Frame stage: Wall frames and roof frames erected. Typically 20% of the contract price.
- Lockup stage: External walls complete, windows and doors installed, property is weatherproof. Typically 20% of the contract price.
- Fixing stage: Internal fixtures, fittings, and fit-out complete. Typically 25% of the contract price.
- Completion stage: Final inspection passed, occupancy certificate issued. Remaining balance drawn.
The lender arranges progress inspections before releasing each draw. Delays in construction or disputes about completion of a stage can delay payment, which can in turn delay the builder. Communication between your broker, lender, and builder throughout the process is important.
Documentation lenders require
Construction loan applications require significantly more documentation than standard home loan applications. Being prepared with these documents from the outset speeds up approval considerably.
- Council-approved plans and development approval (DA) or complying development certificate (CDC)
- Fixed-price building contract signed by both parties
- Builder's licence number and insurance certificates (home warranty and public liability at minimum)
- Land title details or contract of sale if land is being purchased simultaneously
- Soil test and engineering reports for some properties
- Quantity surveyor report for larger projects (typically above $1 million)
Fixed-price contract requirement
Almost all lenders require a fixed-price building contract. Cost-plus contracts, where the final cost depends on actual materials and labour, introduce cost uncertainty that lenders cannot adequately assess. If your builder prefers cost-plus, discuss with your broker which lenders can accommodate this before proceeding.
Owner-builder loans in NSW
Owner-builder loans are available but come with additional restrictions compared to standard construction loans. In NSW, you must hold a valid owner-builder permit issued by Service NSW for projects above $10,000. The permit requires completion of approved training and carries personal liability for defects for seven years.
Lenders take a more conservative view of owner-builder applications because the risk profile is higher. LVR is typically capped at 60%, meaning a minimum 40% equity or deposit is required. The pool of lenders willing to fund owner-builder projects is smaller than for standard construction. A quantity surveyor report is required by most lenders to validate costs and progress at each stage.
How a construction loan differs from a standard loan
The key differences are in how and when funds are advanced, and how interest is calculated. A standard home loan advances the full purchase price at settlement. A construction loan advances funds progressively as the build proceeds.
Standard loans are assessed based on the value of an existing property. Construction loans are assessed on the end value of the completed property, which requires the lender to assess plans, specifications, and the builder's credentials as well as the borrower's financial position. This makes them more complex to assess and approve.
Tips for a smooth construction loan approval
Choose a licensed and insured builder with a track record of completion. Lenders are more comfortable with established builders. Ensure the building contract is fixed-price before approaching lenders. Have your council approvals in place, or at least conditionally approved, before applying.
Work with a mortgage broker who has specific experience in construction lending. The documentation requirements and lender policy nuances are significantly different from standard residential lending. For NSW borrowers, Lend & Loan work across construction loans regularly and understand which lenders are most active in this space.