Why are construction loans so complicated?

Building a home is a complex process that involves multiple parties including builders, contractors, lenders, solicitors, accountants, quantity surveyors and the council. With so many people involved in the process, there’s always the possibility that some experts won’t understand each other’s field and things may go wrong.

It can also be exceedingly complicated to obtain finance. The majority of mortgage brokers and bank employees don’t understand construction at all!

As a result, construction loans are often set-up with many errors. The loan amount may be incorrect or it may be delayed, due to constant amendments. We have created this guide to help you ensure that you don’t have these same frustrations with your construction mortgage.

How does the construction process work?

When you apply for a loan, the lender will need a copy of the building contract/tender and the plans. They’ll ask their valuer to estimate the on-completion value of the property and will assess your loan on the lesser of the land price plus cost of construction or the on-completion value.

Once your loan has been approved, the lender will issue a loan offer for you to sign and return, just like with any other home loan. When your builder is ready to begin receiving payments from the bank he’ll need to provide additional documents, such as the final council approved plans, his insurance & drawdown schedule.

How do you request that the bank pay your builder directly?

• The builder will send you an invoice.
• You’ll then complete and sign a drawdown request form (available from your lender).
• Send the drawdown request form and the invoice to the construction department of your lender.
• The lender may require a valuation to confirm the work that has been completed so far.
• The funds will be advanced to your builder generally within five working days.
• Repeat this process for each progress payment required by the builder.

Changes to building contract?

Did you know that if you make an amendment with the builder and the contract price changes by just $100, the lender may need to reassess the loan all over again?

So how can you avoid changes causing a problem with your home loan?

• Make sure that the building contract you provide the lender with is the final complete contract.
• If you make any small changes then try to pay for them from your own funds, or have the builder reimburse you for any discounts after construction is complete.
• For any large changes, you’ll need to notify the bank and then allow up to one month for the bank to reassess your loan.
• “Keep it simple” works very well with the banks! If you keep making changes then expect to have significant delays.

Minor quotes?

It’s quite common for people to hire contractors to complete other work such as landscaping, utility connections, swimming pools or site works. Try and get all of these minor quotes included in the building contract and then have the builder pay for them.

This may not work for the builder, so discuss this with us and your builder before deciding on the best way to go.

Sometimes the banks will only release funds for other quotes on completion of construction. Be careful because you may have agreed to pay the contractor up front!

One loan or two?

If you’re buying the land, you may want to consider splitting the loan into a “land loan” and “construction loan”, which means that they’ll be advanced at different times. If this isn’t done then you’ll need to put all of your required funds in at the time the land settles. Any LMI will be charged at land settlement.

We’ll discuss this with the lender to confirm their process and find out when you’ll be required to contribute your deposit.

How much deposit do I need?

Most people go over budget! We recommend that you keep saving during the construction process and try to avoid any large expenses until construction is complete.

As a general rule, we try to ensure that you get approval for a slightly higher loan amount. This is to ensure that there are plenty of funds available. There’s nothing worse than running out of funds when your house is almost complete!

If you’re borrowing 100% of the cost of land & construction as with a “family pledge home loan”(guarantor loan), then you’ll still need some funds on standby to allow the builder to create the building contract & apply for council approval. This is because the lender can’t release funds outside of the specified construction drawdowns.

Additional work to be completed by contractors?

In some cases, part of the work isn’t being completed by your builder.

Some common examples are:

• Swimming pool
• Pergola
• Driveway
• Power pole / power connection
• Landscaping
• Site clearing
• Shed, dam or other hobby farm improvements

If you can provide a formal written quote for this work then we can often get the bank to extend the loan for these costs.

It really depends on the nature of the work and the lender that we’re working with as to whether this will be possible or not.

The key is to give us this information at the beginning of the process! If you tell us about the additional work later on then we can’t get the lender to finance it.

Be careful as some lenders will only release money for the additional work once the main house is completed. This may not suit your construction schedule and so in some cases we need to change to another lender.

For the first home buyer who doesn’t have enough savings for a deposit these tips will help you reach your goals.

1. Put your Goals in writing

For most people if your goals are in writing then you are far more likely to achieve them if you don’t.  Even though some tasks like writing down daily expenses can be laborious it will give you a great idea as to where your money is going.  If you find your spending habits could be curtailed then cut it back.  The goal is worth it at the end if the day.

2.  Beat the Credit Trap 

Often people get so caught up in daily living they forget to check how their credit card, personal loans or unpaid bills are looking.  You need to realise you can do something about it.  The first thing to do is tackle the debt with the highest interest rate.  Pay more than the minimum. Over time as the debt reduces you will have surplus cash flow to put towards savings.

3. Make your Savings work for you

The 10% rule here is a beauty.  If you can direct 10% of your net salary to a savings account you are well on the way to getting that deposit.  Many Banks these days have a savings account linked online to a transactional account.  It is this savings account which will earn you higher interest than the normal transactional account.  Do your homework to make sure you are getting best rate out there.

Your deposit does not need to be huge. Once you have worked out how much you can spend on a house, it is a good idea to have saved a minimum of 5% of the value of the house, If, however, you are in a high income position or are purchasing a house later in life, it would be a good idea to have 10% or more.

In general, lenders like to see this money saved over a 3-6 month period. For first home-buyers or borrowers who have no equity in existing property, mortgage insurance may be required. Mortgage insurers want to know if you’re prudent with money or whether you tend to spend everything you get. For that reason, they prefer all borrowers who wish to borrow more than 80% of the value of their property to have genuinely saved at least 5% of the value of their property purchase.

Genuine savings include money in savings accounts, shares or investments (held for 3 months). They do not include first home-buyers grant, a gift from parents, proceeds from the sale of a car, or any other borrowed funds. While these additional funds can be part of your deposit, they are not ‘genuine savings’ in the eyes of the funder.

The capacity to save money is generally regarded as a good indication of a person’s capacity to manage money and is a strong indicator that the added expenses of owning a new home are more likely to be managed properly. Bear in mind that a bank will be increasingly careful as the loan-to-value ratio increases.

Some applicants are often disqualified from a loan, even if they can afford it, as they cannot demonstrate a track record of saving. That is because the money they’ve put forward as the funds to complete the purchase of their property has been given or lent to them. Lenders and mortgage insurers want to see a proven record of thrift to demonstrate the ability for repayment.

Power Financial Solutions has a great range of mortgage calculators to help with all those tough decisions that come with finding the right loan.

First home buyer? Don’t know what to do first?

A good place to start is by getting your head around the various costs associated with buying a property and applying for your first home loan.  When it comes to budgeting to buy a home, the process can feel daunting – especially if you are a first-time buyer.

A good place to start is by getting your head around the various costs associated with buying a property and applying for your first home loan.

While these can vary from state to state, getting a rough estimate together will help you determine how much you will need to borrow – and what kind of a deposit you will require to do so.

Lenders’ fees and stamp duty

A mortgage lender may charge you a fee to value your property and process your loan application. Together, these fees may reach into the region of $1,000, so it is important to be prepared.

You should also be ready for stamp duty, which is calculated on your property as well as the size of your mortgage. Property stamp duty and mortgage stamp duty can vary from state to state – and in many states, there are concessions for first-time buyers who meet specific criteria – so it is important to do your research and ask plenty of questions.

Mortgage insurance

Lenders’ mortgage insurance is a one-off fee that is designed to offer your lender protection in the event that you are unable to repay your loan.

This type of financial product is generally a requirement anytime you borrow against more than 80 per cent of the value of your property. The amount you will need to pay is calculated on a sliding scale and will depend on a number of factors, including your loan-to-value ratio.

Taxes and fees

In addition to the value of your property, the amount of money you have already saved towards a deposit and the fees listed above, there are a number of other important charges you will want to bear in mind.

These include the fees for services carried out by solicitors and conveyancers and will depend on a number of factors, including the amount of work that was done and the amount of time it took.

You will also need to budget for the costs of inspection reports as they are required, as well as any fees associated with enlisting a removalist service on moving day.

Power Financial Solutions has a great range of mortgage calculators to help with all those tough decisions that come with finding the right loan. Have a look at our calculators on our website to help you further.