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8 things to consider when choosing a construction loan
If you want to update your existing property or you want a house customised according to your needs and preferences, building a house instead of buying one can be a good choice. If you’re looking to do this, a construction loan will provide you with the finance you need.
What is a construction loan?
A construction loan is a type of loan that is used to pay for the cost of building a new house or a major renovation. It has a different payment scheme than a traditional home loan because it has progressive payments or draw-downs where the lender releases funds throughout the stages of construction.
Construction generally consists of five stages:
1. Slab down: laying of the foundation
2. Frame up: building of roofing and brickwork
3. Lock up: installation of windows and doors
4. Fixing: putting in place the internal fittings and fixtures
5. Completion: adding of finishing touches and final cleaning of the property
After each stage, your lender will arrange an inspection and then release the funds to the builder for the work. The interest is calculated based only on the funds drawn down, then after construction, your repayments will revert to principal and interest repayments on the entire balance.
What to consider when choosing a construction loan
Construction loans work a bit differently from the regular mortgage. Here are the top things you need to consider when choosing a construction loan:
1. Interest rate: Shop around for a competitive interest rate that will suit your financial situation. Securing the best construction loan rate can give you lower monthly repayments.
2. Interest-only option: This feature will let you make interest-only repayments during the period of construction.
3. Valuation of land and building: Your lender will order a valuation on the land and completed building to determine your loan-to-value ratio or LVR. They will also value every building stage for invoicing before releasing the funds to the builder.
4. Deposit: Most lenders require a minimum deposit of 10 per cent of the final property value. But if you put down more than 20 per cent, you don’t need to pay for Lender’s Mortgage Insurance.
5. Construction loan fees: Monthly fees, settlement fees, and valuation fees can add up. Make sure to take these into account when choosing a construction loan.
6. Financial documents: Just like applying for a regular mortgage, you will need to provide financial documents such as payslips, bank statements and tax returns. The required documents will depend on your lender.
7. Signed building contract: Documents you will need when applying for a construction loan are Contract of Sale for the land and the building contract that will include all the plans and specifications.
8. Builders and tradies: Your lender will approve the builder you select, so it’s important to choose one that is competent, with the right credentials.
Choosing a construction loan that is suitable for your situation and budget will make it possible to build your dream house. It may require some time to complete but the wait will be worth it in the end. Consult your broker for more detailed information.
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