Understanding the basics of Construction Loan Structures

How Construction Loan Structures Differ From Standard Home Loans

A construction loan releases funds in stages as your build progresses, rather than handing you the full amount upfront. You only pay interest on what's been drawn down, which means your repayments start small and increase as more money flows to the builder. Most construction loans operate on an interest-only basis during the building phase, then convert to a standard principal and interest loan once the property is complete.

Consider a buyer with a 10% deposit purchasing suitable land for $250,000 and planning a $400,000 build. In the first month, the lender might release $250,000 for the land purchase and $40,000 for the first progress payment. Interest charges apply only to that $290,000, not the full $650,000 loan amount. As each stage completes and more funds are drawn, the interest calculation adjusts accordingly.

This structure protects both you and the lender. The builder receives payment only after completing specific milestones, and you're not paying interest on money that hasn't been used yet. The trade-off is that construction loans involve more administration, more inspections, and typically a slightly higher interest rate than a standard home loan.

The Two Main Structures: Construction-to-Permanent and Standalone Construction Loans

Most lenders offer a construction-to-permanent loan, which means one application, one approval, and one loan that transitions automatically from the building phase to a standard home loan once construction finishes. The alternative is a standalone construction loan that requires you to refinance into a separate home loan after the build completes, which adds cost and complexity most buyers don't need.

The construction-to-permanent structure is almost always the right choice for first home buyers. You lock in your interest rate structure at the start, avoid a second round of application fees, and the transition from interest-only construction repayments to principal and interest happens without any action required from you.

Some lenders also allow you to fix part or all of your loan during construction, though the fixed rate typically doesn't apply to the drawn portion until the build finishes. Others keep the entire amount on a variable rate until practical completion, then give you the option to split between fixed and variable. Knowing which structure your lender uses matters, particularly if rates are moving.

What a Progressive Drawdown Schedule Actually Looks Like

The progressive drawdown happens in stages tied to your building contract. A typical schedule includes five or six progress payments: base stage (slab or stumps), frame stage, lock-up stage (roof and windows), fixing stage (plaster and internal work), and practical completion. The builder submits a progress claim after each stage, the lender arranges a progress inspection to confirm the work is done, and then releases the next payment.

You don't control the timing of these drawdowns. The builder does. Once they complete a stage and lodge the claim, the inspection usually happens within a few business days, and funds are released shortly after. Most lenders charge a Progressive Drawing Fee for each inspection, typically between $300 and $500 per drawdown, which you should factor into your budget alongside other settlement costs.

In our experience, buyers underestimate how quickly those fees add up. Six drawdowns at $400 each is $2,400, and that's on top of council approval costs, development application fees if needed, and any variations to the building contract. If your deposit is tight, these costs can catch you off guard, particularly if the build takes longer than expected and you're paying interest-only repayments for an extended period.

How Interest Charges Work During the Building Phase

You only pay interest on the amount drawn down so far, and repayments are typically interest-only until the build finishes. If $300,000 has been released and your interest rate sits at 6.5%, your monthly interest charge is roughly $1,625. Once the next $80,000 is drawn, that figure jumps to around $2,058. The repayment amount changes with each drawdown, so budgeting during construction requires more attention than a standard loan.

Some lenders let you make additional payments during the construction phase to reduce the interest burden, though these are usually capped or limited depending on whether you're on a fixed or variable rate. Others structure the loan so that any extra payments sit in an offset or redraw facility and don't actually reduce the amount you're charged interest on during the building phase. Clarifying this before you sign matters, particularly if you're planning to put savings toward the loan while construction is underway.

The interest-only period typically lasts 12 months, though most lenders will extend this if the build runs over schedule. You'll need to apply for an extension and provide updated timelines from the builder, but it's usually approved without much fuss as long as construction is genuinely progressing.

Land and Construction Package vs Buying Land First

A land and construction package bundles the land purchase and building contract into a single transaction, often through a developer selling house and land packages in a new estate. The alternative is purchasing vacant land separately, then arranging your own building contract with a registered builder later. Both approaches work with construction finance, but the structure and timing differ.

With a package, the developer usually requires you to commence building within a set period from the contract date, often six to 12 months. This timeline is non-negotiable, and if you're not ready to start, you risk breaching the contract. The upside is that the land and building contract are coordinated from the beginning, which simplifies the approval process and often means fewer delays.

Buying land separately gives you more control over timing and builder selection, but it adds a layer of complexity. You'll settle on the land first, then apply for construction finance once you've chosen a builder and locked in a fixed price building contract. Some lenders require you to own the land outright before they'll approve construction funding, while others will lend for both the land and the build in one go, provided you have a signed contract with a registered builder and council plans approved.

Fixed Price Contracts and Cost Plus Contracts

Most lenders will only approve construction finance against a fixed price building contract, which sets a total cost for the build and protects you from unexpected expenses. A cost plus contract, where you pay for materials and labour as they're incurred, is much harder to finance because the final loan amount remains uncertain. If you're working with a custom builder who prefers cost plus, expect to either negotiate a fixed price or look for specialist lenders who handle owner builder finance and non-standard arrangements.

The fixed price contract also determines your progress payment schedule. Builders typically structure payments so that each stage covers the costs incurred up to that point, though the actual percentages vary. Some contracts front-load payments, with 40% or more due by lock-up stage. Others spread payments more evenly. Lenders review the payment schedule during the application to make sure it aligns with industry norms and doesn't expose you to unnecessary risk.

If you're planning a custom design rather than a project home, the contract and council approval process takes longer, which can delay your finance approval. Lenders want to see finalised plans and a development application lodged or approved before they commit, particularly if the build involves anything non-standard.

What Happens at Practical Completion

Practical completion is the point where the builder hands over the keys, you're legally allowed to move in, and the loan converts from construction funding to a standard home loan. The lender arranges a final inspection to confirm the property is finished, then releases the last progress payment to the builder. From that point, your interest-only repayments switch to principal and interest, unless you've arranged an ongoing interest-only period as part of your home loan structure.

The transition usually happens automatically, though you should confirm the new repayment amount and structure a few weeks before practical completion so there are no surprises. If you've been paying $1,800 per month in interest-only repayments and the loan switches to principal and interest at $3,200 per month, that's a significant jump, and you'll want to make sure your budget is ready.

Some buyers assume they can extend the interest-only period indefinitely, but most lenders cap it at 12 months for construction loans unless you're purchasing as an investment. If you're building your first home and need longer on interest-only repayments, you'll need to request that upfront during the application, and it may limit your lender options.

Structuring Your Deposit Across Land and Construction

When you're buying land and building with a smaller deposit, the lender assesses your borrowing capacity based on the total project cost, not just the land price. If the land costs $200,000 and the build costs $350,000, your total project is $550,000, and a 10% deposit means you need $55,000 plus settlement costs, stamp duty, and the progressive drawing fees mentioned earlier.

The deposit is usually applied to the land purchase first, with the remainder of the land cost and the full construction amount funded by the loan. Some lenders let you hold back part of your cash deposit to cover progress payment gaps or unexpected costs during the build, while others require the full deposit to go toward the land. Structuring this correctly at the start prevents cash flow problems halfway through construction.

If you're accessing the Home Guarantee Scheme or another low deposit option, the same principle applies. The guarantee covers the portion of the loan above 80% of the total project value, not just the land, so you can build a new home with as little as 5% down, provided you meet the scheme's eligibility criteria and build within the price caps.

If you're looking at a house and land package and want to understand how your deposit works across both components, or if you're trying to figure out whether your savings stretch far enough to cover the build, call one of our team or book an appointment at a time that works for you. We'll walk through your specific numbers, explain what each lender requires, and help you structure the loan so you're not scrambling for cash mid-build.

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