How a Construction Loan Works

If you’re planning to build a new home, chances are you’ve heard the term construction loan. But do you know how it actually works?

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Unlike a standard home loan, a construction loan is designed specifically to fund a home while it’s being built. Understanding how it works can help you plan your budget, avoid surprises, and feel more confident throughout the building process.

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Here we break it down step by step.

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What Is a Construction Loan?

A construction loan is a type of home loan that releases funds in stages as your home is built, rather than providing the full loan amount upfront.

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Instead of paying a builder all at once, the bank or lender pays them progressively as construction milestones are completed.

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How Is a Construction Loan Different from a Standard Home Loan?

The main difference is how and when the money is paid.

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With a standard home loan:

• The full loan amount is released at settlement
• You begin repayments on the full balance immediately

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With a construction loan:

• Funds are released in stages
• You usually only pay interest on the amount drawn so far during construction
• Full repayments begin once construction is complete

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This staged approach helps manage cash flow during the build.

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What are the Construction Loan Stages?

Most construction loans are paid out in progress payments that match the building stages. While stages may vary slightly, they typically include:

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1. Base Stage

Payment is made once the concrete slab or foundations are completed.

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2. Frame Stage

Funds are released when the frame of the house is finished.

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3. Enclosed Stage

This stage covers external walls, windows, and doors — when the home can be “locked up.”

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4. Fit-Out Stage

This includes internal fittings such as cabinetry, plumbing, electrical work, and tiling.

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5. Practical Completion Stage

The final payment is made once the home is completed and ready for handover.

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Your lender may carry out a drive-by, inspect the site at each stage or be happy to accept the invoice with your confirmation that the stage is completed before releasing funds.

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What are my Repayments During Construction?

During the construction phase, most lenders require interest-only repayments.

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This means:

• You only pay interest on the money that has been drawn
• Repayments increase gradually as more funds are released
• You don’t pay principal repayments until construction is complete

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Once the build is finished, the loan usually converts to a standard home loan with regular repayments.

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What Costs Are Included in a Construction Loan?

A construction loan can cover:

• Land purchase (if applicable)
• Building costs
• Site works
• Builder progress payments

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Some costs may need to be paid upfront, such as:

• Deposits
• Council fees

It’s important to clarify with your lender exactly what is included.

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What Do Lenders Look For When Approving a Construction Loan?

To approve a construction loan, lenders usually assess:

• Your income and financial position
• Your credit history
• The building contract
• Builder credentials and licences
• Property valuation (based on the completed home)

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If you would like more information, please reach out to one of our New Home Consultants or if you would like information on the building process click here.

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