Should you use a home loan or a construction loan? The truth is you should use both. When you buy your land, you’ll purchase it using a home loan, but if you want to save thousands of dollars while your home is being built then you’ll want to take out a construction loan for the amount needed to build your home.
Why you need to use a construction loan
When you are building you have options for the type of loan you choose. You can have a standard home loan where you borrow the full amount of the money required to complete the whole project, or you can purchase your block of land using a home loan and get what is called a ‘construction loan’ to finance the construction of your home. There's big advantages to using a construction loan.
When you take out a home loan to finance your entire home building project, including the land, you will generally pay both principal and interest on the full amount from the beginning. When you take out a construction loan you are advanced the funds as required for each stage of the build. The beauty of this is that you’ll only pay interest on the instalments that have already been advanced to you. This means you will save on interest repayments during construction. You’ll only be paying interest on the full amount at the end of the build, by which stage the home loan you took out for your land and the construction loan can be combined into one single home loan. And the best part is that you'll have saved thousands in the process.
construction loan v's home loan
The chart below makes a comparison between normal home loan repayments and construction loan repayments over an eight-month period. These figures have been taken from a four-bedroom home I built in 2016. This example excludes the land component, as a construction loan is only relevant to the actual building component. This chart is also a good way for you to see the breakdown in costs of building a home and how the payment structure of a custom built home might look. (Payment structures and breakdowns vary from builder to builder.)
Note how the loan repayments for borrowing $263,645 upfront are the same each month and are initially much higher than the monthly repayments for a construction loan in which small amounts are advanced each month. Over eight months, the total savings in the construction loan option are a significant $6,446.00.
How To Get Construction Loan When You're Ready To Build
Getting a construction loan isn’t something you apply for during the pre-approval stage. However, you will only want to borrow with a bank who will let you take up that option once the time is right.
It’s only once you have a building contract with a builder that you can actually apply for a construction loan.
When you’re ready to start building you’ll need to apply for your construction loan. However, you can only apply for a construction loan if you have an active contract including a payment schedule with your builder. You must also already have a building permit.
In other words, you need to be ready to go.
If your circumstances haven’t changed and little time has passed since you got pre-approval, you should be able to rely on the information already submitted to your lender when you were establishing your budget at the time of getting pre-approval. If more than three months have passed, you lender will probably need updated information.
in summary
If you're borrowing money to build your home, only ever use a construction loan. Structured correctly by a construction loan expert, it will save you thousands in interest repayments during the time that your home is being built.
quote
The man who removes a mountain starts by carrying away small stones
- Confusious
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