Beginner's Guide to Construction Loan Structures

How Construction Loans Differ from Standard Home Loans

Construction finance releases funds in stages as your build progresses, rather than as a single lump sum at settlement. You only pay interest on the amount drawn down at each stage, which means your repayments start low and increase as more funds are released. Most lenders charge a Progressive Drawing Fee each time they release funds, and you'll typically make interest-only repayments during the build before converting to principal and interest once construction is complete.

Consider a buyer building a custom home in South Perth who has a total loan amount of $650,000. At the first drawdown for the slab, they might receive $100,000. They'll pay interest only on that $100,000 until the next stage is complete and inspected. When the frame is finished, another $150,000 is released, and interest is then calculated on the combined $250,000. The process continues through lockup, fixing, and practical completion, with interest charges rising at each stage.

This structure is quite different from a standard mortgage where you borrow the full amount on day one. With construction loans, your repayments during the build are usually lower than they would be with a standard loan of the same size, because you're only servicing the portion that's been drawn down. Once the build is finished, the loan converts to a construction to permanent loan, and you begin making regular principal and interest repayments on the full amount.

Fixed Price Contracts and Progress Payment Schedules

A fixed price building contract sets the total cost of your build upfront and ties payments to specific milestones. Your builder submits a progress payment schedule that breaks the contract into stages such as base, frame, lockup, fixing, and practical completion. Each stage must pass a progress inspection arranged by your lender before funds are released, which protects you from paying for work that hasn't been completed to standard.

Most lenders across Australia require a registered builder and council approval before they'll consider a construction loan application. The progress payment schedule typically includes five or six stages, and each release is subject to a site inspection by a qualified valuer or building inspector. If the work doesn't meet the required standard, the drawdown is delayed until the issue is rectified. This process gives you some protection, but it also means timing can shift if inspections reveal problems.

The alternative is a cost plus contract, where you pay the builder's costs plus an agreed margin. These contracts are less common for residential builds and can be harder to finance because the final loan amount isn't fixed at the start. Most mainstream lenders prefer fixed price contracts because the risk is more contained, and the builder carries the cost overrun risk rather than you.

Land and Construction Packages in South Perth

A land and construction package combines the purchase of suitable land with a building contract in a single finance structure. You'll need to settle on the land first, then commence building within a set period from the Disclosure Date, which is usually six to twelve months depending on your lender. If you don't start construction within that window, some lenders will require you to refinance or renegotiate terms.

South Perth has a mix of older homes on larger blocks and newer subdivisions closer to the river, which makes it a popular area for knockdown rebuilds and land and build loan scenarios. If you're buying a block with an existing dwelling that you plan to demolish, the lender will usually require the demolition to be complete and council plans approved before the construction loan is activated. That means you may need to hold the land under a standard home loan structure initially, then switch to construction finance once you're ready to build.

In our experience, buyers underestimate how long council approval can take, especially in heritage precincts or areas with specific streetscape requirements. If your development application sits with the council for four months, and your lender's construction commencement window is six months, you're left with very little margin. Planning ahead and starting the approval process before you settle on the land can help, but that's not always possible depending on your contract conditions.

Progressive Drawdown and How Interest is Calculated

You only pay interest on the amount drawn down at each stage, not on the full approved loan amount. If your total facility is $700,000 but only $200,000 has been released, your interest charges are calculated on $200,000. As each progress payment is made, the balance increases and so do your repayments. Most lenders offer interest-only repayment options during construction, which keeps your repayments lower while the build is underway.

Each time funds are released, the lender charges a Progressive Drawing Fee, which typically ranges from $200 to $400 per drawdown. Over a five-stage build, that can add up to $1,500 to $2,000 in fees. Some lenders cap the number of drawdowns or the total fees, so it's worth comparing how different lenders structure their progress payment finance before you commit.

The construction loan interest rate is usually slightly higher than a standard variable rate, often by 0.10% to 0.30%, depending on the lender and your deposit size. Some lenders offer the same rate for construction and the subsequent permanent loan, while others apply a margin during the construction phase and then revert to a lower rate once the loan converts. It's not unusual to see rates vary between lenders by more than the difference between construction and standard loans, so the lender choice often matters more than the product type.

Owner Builder Finance and Custom Design Builds

Owner builder finance is available, but most lenders apply stricter criteria and require evidence that you have the skills, qualifications, or experience to manage the build. You'll usually need to provide detailed council plans, a project timeline, and quotes from subcontractors including plumbers and electricians. Some lenders won't lend to owner builders at all, while others cap the loan-to-value ratio at 70% or 80% and require a larger deposit.

If you're building a custom design home rather than selecting from a project home loan range, the lender will want to see architect-drawn plans, a quantity surveyor's report, and a detailed cost breakdown. Custom home finance can take longer to assess because the lender needs to satisfy itself that the design is practical, the costings are realistic, and the builder is capable of delivering the project. Spec home finance, where a builder constructs a home without a buyer lined up, follows a similar process but is usually only available to builders or developers rather than individuals.

Renovation Finance and House Improvement Loans

A house renovation loan works similarly to new home construction finance, with funds released in stages as the work progresses. The key difference is that you're usually living in the property while the work is done, or you already own it outright and are adding the renovation loan on top of an existing mortgage. Lenders will require a scope of works, quotes from licensed contractors, and council approval if the renovation involves structural changes or an extension.

Renovation finance is often structured as a top-up on your existing home loan, which means you're increasing your total borrowing rather than taking out a separate facility. Some lenders offer a split structure where the existing loan remains on its current terms and the renovation component is drawn progressively. If you're planning a significant renovation in South Perth, particularly on a character home near the river or in one of the heritage precincts, expect the council approval process to add several months to your timeline.

Off the Plan Finance and House and Land Packages

Off the plan finance is used when you're buying a property that hasn't been built yet, typically an apartment or townhouse. The structure is similar to land and construction finance, but the builder is usually a commercial developer rather than a residential building company. You'll pay a deposit when you sign the contract, then settle once the development is complete and a title is issued. The risk is that property values or your financial situation may change between contract and settlement, which can affect your borrowing capacity or the lender's willingness to settle.

House and land packages combine a titled block with a building contract, and they're common in new estates and subdivisions. The finance structure is straightforward: you settle on the land first using the land portion of your loan, then the construction loan activates and funds are released as the build progresses. Most lenders treat house and land packages as lower risk than custom builds because the design is standardised, the builder is usually a volume builder with a proven track record, and the costings are fixed.

South Perth doesn't have large new housing estates, so most house and land activity happens in surrounding areas. If you're considering a package in a neighbouring suburb but want to work with a local mortgage broker in South Perth, the process is the same regardless of where the land is located. The lender will assess the package based on the land value, the building contract, and your ability to service the combined loan.

If you're weighing up whether construction finance suits your situation or whether there's a structure that aligns better with your build timeline and deposit, call one of our team or book an appointment at a time that works for you.

Frequently Asked Questions