Buying a house and building a house is not the same thing.
Financing a house purchase is relatively straightforward. You agree on a sale price, your broker gets you a good deal with a bank that lends you 80% of the cost, and you pay the remaining 20% plus costs. You then settle on a pre-agreed date. Result: the house is yours and you can move in.
Ironically, building or renovating your home seem to invariably end up being hugely stressful and quarrelsome. You feel like no one in the process can stick to what they said!
The homeowner inevitably ends up blaming a combination of the 4 Bs:
- The Builder
- The Bank
- The Broker
- Buddha
Financing construction or a renovation can be a nightmare, but it doesn’t have to be. Construction loans can be up to 90% LVR, but understanding the process in advance and asking your broker to explain it, will help hugely with being able to set expectations and minimise stress.
With building or home constructions loans, banks will insist on the following criteria to be met before granting a loan:
- A licensed builder – The builder undertaking the construction must be licensed and certified. This is also needed even if the owner is a licensed builder.
- A Fixed Price contract – The contract for works must state a fixed price, and the builder must be responsible for any potential cost overruns.
- Timeliness of works – Contract must state reasonable time for completion of works, and stages or milestones must be established.
- “As-is-value” – Funding cannot be based on future post-works valuation.
- Minimum loan amount – Loans of less than $50,000 are rarely considered by banks.
Structural Renovations vs. Home Improvement Loans
When doing renovations on an existing property, most banks will want to simply know:
Are the renovations structural or cosmetic?
i.e. will there be a change to the structural integrity of the property?
Small home improvements, and similar minor works, would unlikely be considered structural changes, e.g. a swimming pool, as it doesn’t change the structural integrity of the property. For these purposes, a bank will grant a building loan up to a certain amount (often up to a limit of $250,000) without any requirements to control the funds. This is referred to as “cash-out”.
However, for an owner-builder construction loan, involving more serious works, i.e. changes in the structural integrity of the property or most work that require a Development Application (DA), the bank considers a risk if the project does not successfully complete as planned, and maybe even reducing the value of the property as a whole. To ensure this doesn’t happen, a bank will insist on having control over the funds. They will only release payments under the conditions mentioned above, i.e. if a licensed builder is contracted, with a fixed price contract, and a reasonable time for completion of works is established.
The example below shows how this is done:
Kate and Sean live in NSW. They buy a block of land and wish to build a home.
The cost of the land was $200,000.
The cost of building the home is $400,000.
[Their stamp duty is significantly less as it is vacant land]
Bank XYZ will lend them 80% of the $200,000 for the land i.e. $160,000. Kate and Sean pay the rest ($40,000) in cash to settle on the land.
The cost of the house build is $400,000. Again, the bank will lend them 80% of this ($320,000) with an owner-builder building loan. Sean and Kate must fund the rest in cash, which is $80,000.
The bank insists on the following conditions:
- Sean and Kate used a licensed, bonded builder/firm to carry out the construction
- The building contract is a fixed price contract.
- The build is carried out in 5 stages.
- A bank valuer inspects the build at each stage and after sign-off, he gets paid.
There are of course variations on the above and no two construction loans are ever the same. There are plenty of different options, e.g. a few lenders are happy with 2 stages of construction finance and have few limits on the percentage of the loan drawdown of any stage.
When getting building advice, it is crucial to get lending advice as well. This should be done well in advance to know what is possible. When you get your loan approval, ask for all the details you agreed in writing. A good broker should let you know what is possible, even at the time of quotation. This can of course change, but at least you know what is potentially feasible and what margin of error you may be able to withstand.
For further information on construction loans or renovation finance, don’t hesitate to call one of our experts to discuss further. Freephone +61 7 5456 2928 or email: [email protected].
