If you are planning to build immediately, or at least fairly soon, a construction loan might be the best option. Most lenders demand that building on a construction loan must start within a specified time, usually between one and three years, depending on which lender you use and whether the property will be owner-occupied or investment.
This mortgage type allows you to draw down segments of the loan amount in stages as they are needed – for the land purchase and then for the stages of construction – which saves you paying interest on the entire loan amount when you don’t need to be.
If you don’t plan to build immediately, and you want the loan for the land without any time pressures, a vacant land loan may be the best option.
While regular mortgage types can be used for the purchase of vacant land, most lenders also offer vacant land loans. Most will go up to a 30-year loan term and finance up to 90 per cent of the land’s value, and some go as high as 97 per cent loan-to-valuation ratio (LVR). Lenders’ mortgage insurance (LMI) would still most likely be payable on any LVR higher than 80 or 85 per cent, depending on the lender.
The vacant land purchase can be used to increase the equity in your existing home or investment property and, while redraw facilities are usually not available on construction loans, they generally are on land loans.
If you have stumbled upon the perfect position for your dream home, future holiday getaway or retirement oasis, but aren’t ready to plan building it yet, the next step is to speak to an expert about the different types of loans that can finance the purchase.
Construction loans are just not as straightforward as simple home loans. There are additional decisions to be made about the structure of the loan, additional documentation is required and the funding is released in an entirely different way.
In addition to documentation about your finances, income and identity, your application for a construction loan needs to include contracts or tenders for the construction, as well as the plans so that a valuation can be performed.
Further documentation will also be required before the first payment is made from the lender to the builder, including a schedule of the payments to be made (called drawdowns), the builders’ insurance details and the final plans that have been approved by the local council.
To avoid having to contribute your full deposit and being charged interest on the entire loan amount from the moment the land purchase settles, you can split your mortgage into a land loan and a construction loan. At settlement of the land purchase, you pay lender’s mortgage insurance (LMI) /how-to-buy-without-a-20-deposit> on the land loan, if LMI applies, and start being charged interest and making repayments on the balance of the land loan. The interest and repayments on the construction portion then kick in only as each drawdown is processed.
The drawdown schedule is very important, as you don’t start paying interest on each portion of the loan until it is paid to the builder – you, the lender and the builder need to be satisfied with the schedule.
For the lender to make each payment to the builder, you will need to fill out a drawdown request form from your lender, and submit it to your builder. The builder can then send the lender your form with an invoice for that part of the payment and, after the lender is satisfied that the work has been completed and is up to the standard expected in the valuation, the drawdown can be completed with a payment to the builder.
Any changes to the contract and plans can trigger a reassessment of the loan, so be as sure as you can be that the plans and contracts the lender sees are final, and it is also worth trying to pay for any small amendments from your own pocket, rather than changing the loan and risking a reassessment.
Problems can also arise when other work on the site that isn’t completed by the builder needs to be paid for, as some lenders only make the remaining funds of the mortgage available after the completion of construction. While some builders will include subcontractors as part of the main contract, meaning that they can be paid by the builder as stages of work are complete throughout the drawdown schedule, others will not do this. Again, this may make it necessary to pay from your own pocket.