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Home Construction loan vs home loan – what’s the difference?

by | Apr 25, 2024 | Uncategorized

You’re ready to take the big step and build your own home, but you’re having the same thoughts as anyone who is building a new home: How am I going to afford this? You’ve no doubt heard of both home loans and construction loans but may be scratching your head, wondering what’s the difference between the two. Well, scratch that head no more, because Buildi is here to give you a rundown of what each loan type involves and how to determine which one is the best for your situation.

How is a home loan structured?

Home loans are usually used for purchasing existing property rather than for building a new house. A traditional home loan is structured to provide the borrower with one lump sum of the agreed-upon loan amount. This payment is usually made upon settlement, however, always make sure you understand your agreement with your specific lender.

When it comes to paying back the loan, most home loans will schedule monthly repayments, starting immediately. The amount you need to pay back will be determined based on your total amount borrowed and any interest payments.

Interest payments

With home loans, there are two options when it comes to interest: fixed interest rates and variable interest rates. Both have their pros and cons, depending on your financial situation, so here’s a brief rundown on each.

Fixed Interest repayments

A fixed interest rate means the interest repayments will remain the same throughout the length of your loan. This will protect you from rising interest rates, though if interest rates happen to fall, you won’t see the benefits. Fixed-interest home loans tend to be less flexible when it comes to terms and conditions. However, the peace of mind that comes with knowing exactly how much you’ll be paying throughout the life of the loan and when is worth it for many people.

Variable Interest rate

Variable interest rate loans are influenced by the hikes and drops in interest rates, meaning your monthly payments could vary throughout the loan. When done well (and with a little luck on your side) this could potentially mean you end up paying less, especially if you take out the loan in a declining interest rate market. Statistically, those who do take out a variable rate loan end up paying less interest than those who take out a fixed interest loan. However, it is a gamble and if interest rates skyrocket, you’re going to end up paying more.

How is a home construction loan structured?

Construction loans are designed for those looking to build a new house. The most notable difference between a construction loan and a home loan is how the lender pays the money. Whereas a home loan pays the entire sum of the loan in a single transaction, a construction loan is paid in instalments throughout the building process.

Progress payments schedule for Construction loan

Below is the usual payment schedule for a construction loan and the percentage of the payment you can expect at each stage of the build. Remember, this is how much the lender is giving you throughout the construction process, not your repayment schedule.

Initial Deposit (5% of payment)

Slab (15% of payment)

Frame (20% of payment)

Lock-up (20% of payment)

Fit-out (30% of payment)

Completion (10% of payment)

What are the key differences between a construction loan and a home loan?

The two key differences between construction loans and home loans are what type of projects they’re for and how the loans are given to the borrower.

  • Home loans are primarily for purchasing pre-existing properties whereas construction loans are for funding the building of a house.
  • A construction loan is paid in instalments throughout the building process whereas a home loan is paid in a single lump sum.
  • A home loan will have interest on the full amount from the beginning. With a construction loan, you will be charged interest on the amount you’ve received.

How do interest rates of construction loans and home loans compare?

When you take out a traditional home loan, the interest will apply to the complete sum of money from the get-go. With a construction loan, you’ll only be charged interest on the amount of money you’ve been given. For example, if you’re only up to the slab stage of the building process, you’ll only be charged interest on around 20% of your loan until the next payment is made. This means that with a construction loan, your interest will increase as the process progresses.

How do loan requirements and eligibility differ between home loans and construction loans?

Construction loans typically have stricter requirements than traditional home loans due to the higher risk to the lenders. A construction loan will require more documentation and may come with a higher interest rate. It may be a requirement that you prove your builder is registered and that your building insurance has been organised.

Why are construction loans deemed riskier loan by lenders?

Construction loans will usually require a larger down payment than a home loan due to being considered riskier. The reason lenders consider a construction loan riskier is due to the property not existing. With a home loan, the house and property are pre-existing so there are fewer variables than when you’re starting from scratch. Therefore, interest rates are likely to be higher on a construction loan.

Are there any differences in the application process you need to consider?

Both types of loans will require you to provide documentation. For both home loans and construction loans, you’ll need to provide details regarding finances. This includes bank statements, creditworthiness, and proof of income. For a construction loan, you’ll need to supply additional documents relating to the proposed project, including plans and permits, timelines, the building contract and timelines. Your lender may ask for additional documentation depending on their lending criteria.

Our tips for helping choose the right construction loan

  • Talk to your financial advisor about your financial situation and design a realistic budget.
  • Look at several different construction loans so you can compare. Going with the first construction loan you see could mean you miss out on a better deal.
  • Talk to a building broker like Buildi. We can advise you on a range of matters throughout the building process.

Buildi is here to help you throughout your home

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Building a Home

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