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Construction Loans and Progress Payments

If you’re building a new home instead of buying existing, a construction loan is different from a standard mortgage. Understanding how it works helps you manage cash flow and timeline.

A construction loan is a short-term loan that funds the building process in stages. Instead of borrowing a lump sum at settlement (as with a purchase), you borrow as construction progresses—typically in 5–10 progress payments.

How it works:

  1. You sign contracts with a builder for AUD 500,000 (for example).
  2. The lender approves a construction loan for AUD 500,000.
  3. As construction progresses, the builder requests progress payments. These are typically tied to completion milestones (e.g., 20% at foundation, 40% at frame, 60% at lock-up, 80% at practical completion, 100% at final).
  4. You (or your lender) pay the builder at each stage. You only pay interest on the amount borrowed so far, not the full loan amount.
  5. Once construction is complete and you take possession, the construction loan converts to a standard mortgage.

Interest during construction:

Construction loans charge interest-only during the build phase. You don’t make principal repayments yet. Interest is calculated only on the amount borrowed to date.

Example:

  • Loan: AUD 500,000
  • Year 1 (first 20% borrowed, AUD 100,000): you pay interest on AUD 100,000
  • Year 2 (another 30% borrowed, total AUD 300,000): you pay interest on AUD 300,000
  • This continues until the full amount is borrowed

At completion, the loan converts to a standard mortgage with principal + interest repayments.

Cost advantage:

Construction loans are cheaper than borrowing the full amount upfront for a purchase, because you’re only paying interest on the amount used.

Why this matters:

If you borrow AUD 500,000 upfront but only use AUD 100,000 in year 1, you’re paying interest on AUD 400,000 you haven’t used yet. That’s unnecessary cost. Construction loans avoid this.

Timeline risks:

Building delays are common. If construction takes longer than expected, you’ll pay more in interest (because you’re in the interest-only phase longer). Budget for delays.

Budget risks:

If construction costs exceed the contract price, you’ll need to find extra funds. The lender won’t automatically increase the loan. You either pay the difference from savings or negotiate with the builder.

Inspections:

The lender will conduct inspections at each progress payment stage to confirm construction is proceeding as planned. If there’s a dispute about the stage of completion, inspections determine what gets paid.

Risks to manage:

  1. Builder delays: budget for construction to take longer than planned (add 3–6 months)
  2. Cost overruns: ensure your budget has a 10% contingency
  3. Interest rate changes: construction loans might have variable rates. Budget for rates rising during the build phase.
  4. Completion risk: ensure your builder is financially stable and has a good track record

A realistic scenario:

Contract price: AUD 500,000 Build timeline: 12 months Interest rate: 5% (interest-only) Contingency: 10% (AUD 50,000) added to budget

Progress payments:

  • Months 1–3 (foundation): 20% (AUD 100,000)
  • Months 4–6 (frame): 30% (AUD 150,000)
  • Months 7–9 (lock-up): 25% (AUD 125,000)
  • Months 10–11 (fitout): 15% (AUD 75,000)
  • Month 12 (completion): 10% (AUD 50,000)

Interest costs (assuming funds are borrowed mid-period):

  • Year 1: roughly AUD 12,500 in interest (average AUD 250,000 borrowed for 12 months at 5%)

Once complete, the loan converts to a 25-year mortgage at the agreed rate. You then have principal + interest repayments.

Advantages of construction loans:

  1. You control payment timing (matched to construction progress)
  2. Interest costs are lower than borrowing upfront
  3. You only pay for what you’ve used
  4. You get a brand-new property with your specifications

Disadvantages:

  1. Timeline risk (delays increase interest costs)
  2. Cost overrun risk (you need to fund differences)
  3. Complexity (more moving parts than a simple purchase mortgage)
  4. Builder risk (if the builder fails, you might be left mid-construction)

Mitigation:

  1. Choose an established builder with a good track record
  2. Include a clause allowing you to walk away if the builder goes bust
  3. Get fixed pricing where possible (not cost-plus)
  4. Set realistic timeline expectations (add 20% to builder estimates)
  5. Have contingency funds (10%+ of contract price)

Construction loans are a good option if you’re building new, but they require more careful planning and risk management than purchasing an existing property.