By Ashish Shrestha | Triple O Finance
Building a home is exciting, but financing construction works differently from buying an established property. Your lender doesn't usually hand over the entire building loan upfront. Instead, the builder receives payments as construction progresses.
Understanding when the money is released, how interest is calculated and which expenses sit outside your building contract can help you avoid costly surprises.
How Do Construction Loans Work? The Short Answer
With a construction loan, the lender generally approves a facility based on the proposed project but releases the building funds progressively as construction milestones are completed.
The builder submits a progress payment claim. The lender checks the claim against its requirements, may arrange an inspection and then releases the approved payment.
During construction, repayments are commonly interest-only, calculated on the amount of the loan that has actually been drawn.
You generally do not receive the entire construction loan upfront. Building funds are released in stages, usually to the builder, and interest is charged on the outstanding drawn loan balance.
If you also have a land loan, interest on that existing land debt continues separately or as part of the combined facility. This is an important distinction when calculating your total repayments.
How Is a Construction Loan Different From a Standard Home Loan?
When you buy an established property, the lender generally advances the approved loan funds at settlement. You then begin making repayments on the amount borrowed.
Construction finance is different because the lender is funding a property that is not yet complete.
Rather than releasing all the building funds at once, the lender progressively advances money as the property's construction value increases.
| Feature | Established home loan | Construction loan |
|---|---|---|
| Funds released | Generally at settlement | Progressively during construction |
| Property condition | Usually completed | Built during the loan period |
| Repayments | Commonly principal and interest | Commonly interest-only during construction |
| Valuation | Existing property value | Proposed completed property value |
| Inspections | Valuation as required | Progress inspections may be required |
| Major risk | Settlement and ongoing repayments | Cost overruns, delays and funding gaps |
This is why construction lending requires more than simply comparing interest rates. The lender's drawdown process, construction period, builder requirements and treatment of variations can all affect the project.
The Six Common Construction Progress Payment Stages
Most residential building contracts contain a progress payment schedule. The exact number, names and percentages of stages depend on the builder, contract and applicable state requirements.
The deposit is not necessarily funded as an ordinary construction loan progress drawdown. Depending on the lender and project structure, you may need to pay it from your own funds.
Similarly, the lender's progress payment schedule may not exactly match the builder's proposed payment schedule. Any differences should be resolved before signing the building contract.
Residential building contracts are subject to specific deposit and consumer protection requirements. NSW generally limits the deposit under a residential building contract to 10% of the contract price. Your solicitor should check the contract and payment schedule against the applicable law.
How Does a Construction Loan Progress Payment Actually Work?
Suppose your builder has completed the frame stage and sends you an invoice requesting the next progress payment.
The process commonly works as follows:
- Builder issues the claim. The builder requests payment for the completed contractual stage.
- You review the claim. You check that the claimed stage has been completed as required by the contract.
- The claim is submitted to the lender. You or your broker provides the invoice and any required drawdown authority.
- The lender checks the request. The lender may arrange a progress inspection or valuation before releasing funds.
- The payment is released. Once the lender's requirements are met, the approved funds are generally paid to the builder.
Not every lender physically inspects every stage. Some rely on valuation reports, documentation or other verification methods. The process depends on lender policy.
A lender's progress inspection is primarily for its security and lending requirements. It is not a substitute for an independent building inspection assessing workmanship, defects or contractual compliance.
Do You Pay Interest on the Full Construction Loan?
Generally, no.
During the construction period, interest is commonly calculated on the amount that has been drawn rather than the entire approved but undrawn construction facility.
For example, if your approved construction facility is $600,000 but only $150,000 has been drawn, interest on that construction component is calculated on the outstanding $150,000 balance.
As further progress payments are made, the drawn balance increases, and so does the interest payable.
A construction loan can have small repayments at the beginning and much larger repayments near completion, even when the interest rate has not changed.
Many lenders offer interest-only repayments during construction, with the loan commonly moving to principal and interest repayments after the construction period.
The exact repayment arrangement depends on your lender, product and loan agreement.
Construction Loan Repayment Example: $600,000 Build
Let's look at how monthly interest could change as construction progresses.
| Stage | Total amount drawn | Approx. monthly interest |
|---|---|---|
| Early construction | $60,000 | $325 |
| Slab completed | $150,000 | $813 |
| Frame completed | $270,000 | $1,463 |
| Lock-up completed | $420,000 | $2,275 |
| Fixing completed | $540,000 | $2,925 |
| Fully drawn | $600,000 | $3,250 |
Figures are illustrative and calculated using drawn balance × 6.50% ÷ 12, rounded to the nearest dollar. Actual interest is generally calculated daily and charged according to the lender's terms. This example excludes land debt, fees, rate changes and additional repayments.
Notice the difference between the early repayment of approximately $325 per month and the fully drawn interest-only amount of approximately $3,250 per month.
That's a difference of $2,925 per month on the construction component alone.
What happens when principal and interest repayments begin?
Using the same $600,000 balance and 6.50% interest rate, repayments over a hypothetical 30-year principal and interest term would be approximately $3,792 per month.
However, if the 30-year term began before construction and part of that term has already elapsed, repayments after completion would be calculated over the remaining loan term and could be higher.
The Biggest Construction Loan Budgeting Mistake
Many borrowers focus on what the construction loan repayments will be when the build begins.
The problem is that those early repayments can be misleading.
During construction, you may be paying for two housing arrangements at the same time.
- Interest on your land loan and progressively drawn construction loan.
- Rent or mortgage repayments on the property where you currently live.
This overlap often becomes most expensive towards the end of construction, when most of the loan has been drawn but the new home is not yet ready to occupy.
Consider this example
A family is paying $750 per week in rent while their new home is being constructed.
That is approximately $3,250 per calendar month in rent.
If their construction component is fully drawn at $600,000 and the interest rate is 6.50%, the construction interest alone would be approximately $3,250 per month.
Approximately $6,500 in rent and construction loan interest, before allowing for any separate land loan repayments or other property expenses.
A household that comfortably manages the early construction repayments may find the final months significantly tighter.
The better approach is to model your repayments at full drawdown, include your existing housing costs and allow for construction delays.
What Do Lenders Assess for Construction Loans?
Construction lending involves additional checks because the lender is financing a property that has not yet been completed.
1. Fixed-price building contract
Many mainstream lenders prefer or require a fixed-price building contract from an appropriately licensed builder.
Cost-plus contracts and owner-builder projects can be more difficult to finance, and some lenders do not accept them.
2. Approved plans and specifications
Lenders generally require relevant plans, specifications and evidence of the approvals needed for the proposed construction.
These documents help establish what is being built and support the valuation process.
3. Valuation on completion
A lender generally assesses the proposed completed value of the property based on the land, building plans and construction contract.
That value is not necessarily equal to the total amount you spend on the project.
If the completed valuation is lower than expected, the lender may limit the amount it is prepared to advance.
4. Builder credentials and insurance
Lenders may assess the builder's licence, registration, experience, insurance arrangements and other requirements relevant to the project.
In NSW, eligible residential building work may also require Home Building Compensation cover under the applicable rules.
5. Borrower's financial position
As with other home loans, the lender assesses income, living expenses, existing liabilities, deposit or equity and capacity to service the proposed debt.
For construction lending, the assessment generally needs to account for the proposed completed loan exposure, not just the small initial drawdown.
What Costs Might Be Excluded From Your Building Contract?
A fixed-price building contract does not necessarily mean every expense associated with your new home is included.
The exclusions depend on the builder and the contract. Common items to check include:
- Additional site preparation or unexpected ground conditions.
- Retaining walls and certain drainage works.
- Landscaping, turf and garden works.
- Driveways, pathways and fencing.
- Window coverings and flyscreens.
- Floor coverings where excluded from the package.
- Letterbox, clothesline and external accessories.
- Service connections and utility-related charges.
- Additional council or approval-related costs.
- Upgrades and variations requested during construction.
Some builders include many of these items. Others do not. The only reliable approach is to review the inclusions, exclusions, specifications and allowances in your actual contract.
Just because an expense is necessary to finish or occupy your home does not mean your lender will automatically provide additional funds to cover it.
Where items are excluded, determine whether they can be included in the approved project budget or must be funded separately.
What Happens if You Make Changes During Construction?
Building variations are one of the most common reasons a project costs more than originally expected.
You might decide to upgrade the kitchen benchtop, change flooring, add electrical points or modify cabinetry.
Individually, these changes may seem manageable. Collectively, they can add thousands of dollars to the building cost.
Will the bank pay for variations?
Not automatically.
If the variation increases the amount required beyond the approved construction facility, you may need to fund it yourself or request additional lending.
Any request for additional lending is subject to the lender's assessment and may require updated documents, valuation information or revised building details.
Even where you have sufficient approved undrawn funds, the lender may require the variation to be documented and accepted before it can be funded.
Confirm its total cost, whether it affects the construction timeframe, when payment is required and whether your lender will fund it.
It is usually easier to make decisions about finishes and upgrades before the building contract is finalised than to manage substantial changes during construction.
What Happens if Construction Takes Longer Than Expected?
Building projects can be delayed by weather, material availability, labour shortages, approval issues, variations or builder scheduling problems.
Delays matter financially because interest continues on the drawn loan balance while construction remains incomplete.
If you are renting, you may also need to continue paying rent for longer than expected.
Example: A three-month delay
Assume you are paying $750 per week in rent and approximately $3,000 per month in interest on your drawn construction loan.
A further three months at those amounts could involve approximately:
| Expense | Three-month estimate |
|---|---|
| Rent at $750 per week | $9,750 |
| Construction interest at $3,000 per month | $9,000 |
| Total housing outgoings | $18,750 |
This illustrates the cash required during the additional three months, not necessarily the incremental economic cost compared with an on-time build.
Some interest and housing costs would also arise under the original schedule. The calculation excludes any separate land loan, other expenses and changes in interest rates.
What if the construction loan period expires?
Construction loan facilities commonly have a specified period within which the building work must be completed or the approved funds drawn.
If the project exceeds that period, the lender may require an extension, updated documents or a further assessment.
Extensions are not necessarily automatic. The lender's requirements should be checked well before the facility reaches its deadline.
What Happens When Construction Is Completed?
When the builder reaches the contractual completion stage, the final progress payment process begins.
Depending on the lender and project, this may involve a final inspection, completion documents, relevant certificates, evidence of insurance and confirmation that the lender's requirements have been satisfied.
Your building contract may also contain specific procedures for practical completion, defect lists, final payment and handover.
These contractual matters should be reviewed with your builder and solicitor, rather than relying solely on the lender's inspection.
Do construction loans become normal home loans?
In many cases, the loan moves from the construction phase into its ongoing repayment arrangement.
That commonly means interest-only repayments during construction change to principal and interest repayments after completion.
The timing and repayment structure depend on the loan agreement.
This is another reason to understand your repayments after construction before you begin building.
Construction Loan Checklist: Before You Sign the Building Contract
Before committing to your builder, consider the following questions.
- Have you confirmed your borrowing capacity? Understand the total amount the lender may be prepared to advance.
- Does the lender accept the proposed builder and contract? Confirm lender requirements before signing where possible.
- Does the payment schedule align with the lender? Check deposit requirements, progress stages and any funding gaps.
- What is excluded from the contract? Review site costs, finishes, landscaping, connections and other expenses.
- Can you afford repayments at full drawdown? Include your land loan, rent or existing mortgage.
- Have you allowed for delays? Consider the effect of additional months of housing costs.
- Who pays for progress inspections? Understand lender fees and any independent inspections you arrange.
- How will variations be funded? Establish the approval process before requesting additional work.
- What happens if the construction period expires? Ask about extensions and reassessment requirements.
- Has your solicitor reviewed the building contract? Obtain independent legal advice before signing.
It is also worth discussing a realistic contingency with your broker and builder. The appropriate amount depends on the project, contract and your financial circumstances.
How Triple O Finance Can Help With Construction Lending
A construction loan is more than a home loan with a different repayment schedule.
Lender policies can differ on acceptable builders, contract types, valuations, progress payments, interest-only periods, construction timeframes and variations.
At Triple O Finance, we help borrowers understand how those requirements apply to their proposed construction project.
Our process involves reviewing the borrower's financial position, considering suitable lender policies, assessing the proposed loan structure and helping coordinate the finance process.
For borrowers working in emergency services, healthcare and other professions, income may include overtime, shift penalties or allowances.
How lenders assess those income components can affect borrowing capacity and the available options.
We also encourage borrowers to consider the ongoing financial commitments throughout construction, rather than focusing only on the initial repayment.
The Bottom Line
Construction loans generally release funds progressively as the builder completes agreed stages.
During construction, interest is commonly charged on the amount drawn, which means repayments increase as the build progresses.
The biggest risks often arise from costs outside the building contract, variations, delays and the overlap between construction interest and existing housing costs.
Understanding those issues before signing the building contract can make the financing process more predictable.
Planning to Build a Home?
Before signing your building contract, understand how your lender will assess the project, when funds will be released and what your repayments could look like throughout construction.
Triple O Finance can help you explore your construction loan options and understand the finance requirements for your proposed build.
Get a Free AssessmentImportant information: This article provides general information only and does not constitute personal financial, credit, building or legal advice. Lending criteria, construction drawdown arrangements, interest rates and repayment structures vary between lenders and may change. All examples are illustrative and do not represent a loan offer or guarantee of approval. Building contract terms, statutory requirements and consumer protections differ between Australian states and territories. Obtain independent legal advice before signing a building contract and seek appropriate building, valuation or technical advice where required.
