What is a construction loan?
A construction loan is a loan from a bank which allows you to either build a new home or complete a major renovation on an existing home.
The main differences between an ordinary home loan and a construction loan are,
- a construction loan requires the property owners / borrowers enter into a fixed price building contract,
- an on-completion valuation is completed based on the value of the property once the construction works have been completed and
- payments made in accordance with the fixed price building contract are authorised by the property owners / borrowers but paid directly from the bank to the builder.
The main benefit of a construction loan is the ability to borrow against the future / on-completion value of the property versus the current valuation of a property.
Example
Lets assume you have house worth $600,000 and a mortgage of $480,000 which equates to an 80% loan to value ration (“LVR”).
You plan to spend $200,000 on renovations and once complete the property is estimated to be worth $800,000.
You would not be able to simply take out a further $200,000 mortgage against your home because, you do not have sufficient equity in your home for banks to allow this and your incumbent bank would typically require their consent before you entered into major structural renovations of this nature.
However, once you enter into a fixed price building contract and your lender / broker has organised an on-completion valuation, you can rely on the property’s on-completion value to borrow.
Assuming the property’s on-completion valuation comes back at $800,000, your on-completion LVR would equate to 85% (based on debt of $480,000 + $200,000).
As your LVR is above 80%, you would generally be required to pay Lenders Mortgage Insurance (“LMI”) although there are some exceptions to this for certain individuals in the medical, accounting and legal professions.
Alternatively, to avoid LMI in this situation, you could contribute some of your savings to keep you LVR to a maximum of 80%.
The on-completion valuation as assessed by an independent valuation can have a significant impact on the viability of any new build or renovation project.
Naturally, there are a lot of uncertainties when building a new home or renovating so it is very important to ensure you have a contingency in place for any costs which aren’t specifically included within the fixed price building contract. Our experience suggests this should be a minimum 10% to 20% of the build price.
Way forward
Not all banks do construction loans and each bank has different terms and fees which are applicable so it is important to get advice around which lender might suit you when it comes to taking out a construction loan.
We can help you with this. Simply email us at info@blambles.com.au or call 1300 955 759 — together we’ll uncover your best option.
Cheers
Campbell.
Invest wisely, borrow carefully, and sleep comfortably.
