Construction Loans Explained: How to Finance Your Dream Build

Building your own home is exciting. You get to choose the layout, finishes, colours and all the little details that make it yours.

You also get to make approximately 4,000 decisions about tapware, tiles and whether you really need that extra power point.

But before any concrete is poured or walls go up, there is one important detail to sort out: how you are going to fund the build.

That is where a construction loan comes in.

What Is A Construction Loan?

A construction loan is a type of home loan designed to fund a new build or major construction project.

When you buy an existing home, your lender will generally release the full loan amount at settlement. The seller gets paid, you get the keys and the mortgage begins.

A build works differently because there is no completed house to purchase on day one.

Instead of giving you all the money upfront, the lender generally releases the loan progressively as construction moves through its agreed stages. This is commonly known as a progressive drawdown or progress payment structure.

In simple terms: the bank releases the money as the house takes shape.

What Does The Bank Need Before You Start?

Before approving your construction finance, the lender will want to understand exactly what is being built, what it will cost and what the finished property is expected to be worth.

Depending on the lender and project, this may include:

• Your building plans and specifications
• A signed building contract
• The construction budget and payment schedule
• Building consent
• Evidence of your deposit or available equity
• An insurance plan for the build
• A registered valuation based on the completed home
• Details about the builder and construction timeframe

The bank will also assess your income, existing debts, deposit and ability to manage the loan – just as it would with a standard mortgage.

The difference is that it is assessing both you as the borrower and the viability of the project.

How Do Progressive Payments Work?

Your building contract will usually divide the project into several payment stages.

These could include:

1. Deposit
2. Foundations
3. Framing
4. Roof or lock-up
5. Interior fit-out
6. Practical completion

The exact stages will depend on your contract, builder and lender.

When a stage is completed, a drawdown request is submitted to the bank. The lender may need supporting invoices, confirmation from your builder or an inspection before releasing the next payment.

The funds are then generally paid to the builder or relevant supplier.

This means the full loan is not sitting in your account waiting for someone to discover an expensive European tapware catalogue.

Do You Pay Interest On The Full Loan?

Generally, no.

During construction, you will typically pay interest only on the amount that has been drawn down so far – not the total amount approved.

For example, imagine your approved construction loan is $800,000.

If only $200,000 has been released for the land, foundations and early building work, you would generally pay interest on the $200,000 balance rather than the full $800,000.

As more money is released, your loan balance increases and so does the amount of interest you pay.

This progressive structure can help make repayments more manageable while the home is being built, particularly if you are also paying rent or servicing a mortgage on another property.

However, the exact repayment structure, interest rate and loan terms will vary between lenders.

What Happens When The House Is Finished?

Once construction is complete, the lender will usually need confirmation that the property has been finished to an acceptable standard.

This may involve:

• A final inspection or valuation
• Your Code Compliance Certificate
• Confirmation that all invoices have been paid
• Updated insurance for the completed home
• The final drawdown request

Once the lender’s requirements have been met, the construction loan will generally transition into a more conventional home loan structure.

At that point, you may begin making principal-and-interest repayments and could have the option to restructure or fix portions of the loan, depending on the lender and your circumstances.

What Could Catch You Out?

Construction loans are not necessarily more difficult than normal home loans – but there are more moving parts.

One of the biggest risks is a budget blowout.

Changes to the plans, upgraded materials, additional site work, delays and unexpected construction costs can all increase the final price. Those “small upgrades” also have a habit of becoming surprisingly large once you multiply them across an entire house.

It is important to understand:

• What is included in your building contract
• What is excluded
• Whether the price is fixed
• How variations will be approved and funded
• How much contingency you should keep available
• Whether you can service the loan if the build takes longer than expected

You also need to plan for costs that may sit outside the main construction contract, such as landscaping, driveways, curtains, appliances, professional fees and council-related expenses.

Having the right finance approved is important. Having a realistic overall budget is just as important.

Can A Construction Loan Help You Build Your Dream Home?

Potentially, yes.

A construction loan can provide a structured way to fund a new home without needing the entire building cost available in cash from day one.

It may be suitable if you are:

• Buying land and building a new home
• Replacing an existing house
• Completing a substantial renovation
• Building an investment property
• Using equity from your current home to fund your next project

However, every lender treats construction finance differently. Their requirements, acceptable contracts, deposit rules, valuation processes and drawdown procedures can vary.

The lender offering the sharpest advertised interest rate may not necessarily be the lender best suited to your build.

How The Mortgage Hub Can Help

The finance should be planned alongside the build – not hurriedly added after you have signed a contract.

The Mortgage Hub team can help you understand:

• How much you may be able to borrow
• How your deposit or existing equity could be used
• Which lenders may be suitable for your type of build
• What documents you will need
• How progressive payments will work
• How to structure the loan during construction
• How to manage an existing mortgage or rent while building
• What financial buffers you may need
• How the loan could be structured once the house is complete

We can also work alongside your builder, accountant, solicitor and other advisers to help make the finance process clearer and keep everyone moving in the same direction.

Because building your dream home should involve plenty of excitement but ideally fewer financial surprises.

Follow Our Own Building Journey

Our directors, Mils and Jo Muliaina, are currently building their dream family home at Waihī Beach and documenting the entire journey through our Behind the Build series.

They are sharing everything from funding the project and choosing the right team to the decisions, delays, wins and lessons that come with building a home.

Follow The Mortgage Hub on Instagram to see how it all comes together.

Thinking about building but not sure where to begin? Send our team a message. Our advice is free, and we are happy to help point you in the right direction.

Prefer to watch rather than read?

Watch the video below with The Mortgage Hub Director Mils Muliaina, who explains how construction loans work and what you should know before starting your dream build.

This article provides general information only and does not constitute personalised financial advice. Lending criteria, terms and conditions apply and will vary between lenders.