Financing Your Land And Construction Project
As a potential homeowner or investor, building your property from scratch comes with many benefits. Control over design specifications, fewer maintenance issues moving forward, lower energy costs and the ability to access greater tax incentives through depreciation make this an attractive option for many buyers.
A further financial upside of buying a block and then building is that stamp duty is only paid on the land, not the construction, therefore reducing your overall costs.
If this is the choice for you, securing finance is one of the first steps - as without funding, a construction project will never get off the ground.
So how do you go about financing your build, and what are some of the potential risks to look out for?
It’s a process: securing finance
The process of financing a new build is different from established property as it involves two distinct components: land and construction.
You can obtain a packaged finance product that covers both: when signing the land contract you will be required to put down a 10% deposit, and then a 5% deposit when signing the construction contract.
On settlement of the land, you will pay your full contribution for the land and the build cost. The bank will then settle the balance for the land, and finance the entire build cost.
Interest is charged on the amount drawn, so initially, this will only be on the land component of the loan.
Generally, there are five staged payments to complete a house. After each stage is completed, the bank will pay the invoice and interest will be charged as each drawdown is made.
What is required in terms of LVR?
The required Loan to Value ratio (LVR), which is the amount of a loan compared to the value of the property, will differ for buyers looking to purchase their own home compared to those looking to invest.
For owner-occupier applicants, 90% finance or even up to 95% finance through some lenders is achievable. While for investors looking to obtain land and construction finance, 90% is currently the maximum.
Both homeowners and investors looking to borrow over 80% of the total land and construction value are required to obtain Lenders Mortgage Insurance (LMI). In some cases, this can be added to the loan, while in other instances, depending on the lending limit, the LMI needs to be paid on settlement.
Potential pitfall: and how to avoid it
Before signing a contract, potential investors or future homeowners should always obtain pre-approval, so they can be confident that their bank or financial institution will lend the total amount of financing required to settle.
Both contracts for the land and construction can be signed subject to finance. Then, the total land and construction project can be valued prior to the purchase becoming unconditional; to help ensure enough funding is secured and there is no shortfall.
Let’s look at the breakdown of the numbers on a project with a land price: $300k and construction cost: $300k.
Land price: $300k
Construction cost: $300k
Loan: 80% LVR
Total cash deposit required: $120k
Total loan: $480k
Additional costs to settle: $15k (approx)
Once a buyer has obtained conditional approval for financing, 10% will be paid on the land ($30k) and 5% on the construction ($15k).
The balance of funds required for the total cash deposit is $75k. The loan to settle the land is $195k, and the loan to settle the construction is $285k. Having paid $15k up front, this means the bank pays the remainder of your construction cost.
Understanding the process is key to your success
Whether you are hoping to create that dream home or looking to make a solid investment, purchasing a block and building new is a great option. As with any purchase, however, understanding the financial process and any potential risk is key to your overall success.
All information provided in this article is of a general or factual nature only and does not take into account your personal circumstances or objectives. Before making any decisions, you need to consider, with or without the assistance of a licensed adviser or broker, the appropriateness of any material presented in light of your individual needs and circumstances. The information in this article does not constitute a recommendation for any of the products or services provided by SMATS Services (Australia) Pty Ltd and or any of its related entities.