What are Construction Loan Features?

When you finance a build rather than purchase an established property, you pay for the project in stages as construction progresses.

This means the loan works differently to a standard home loan. Instead of receiving the full loan amount upfront, funds are released at specific milestones throughout the build. You only pay interest on the amount drawn down so far, not the total approved loan amount. For first-time investors, understanding these features determines how much capital you need to hold during construction and what your monthly costs will look like before the property generates rent.

Progressive Drawdown: Paying Only for What's Built

Funds are released in instalments based on a progress payment schedule that matches the stages of construction. Your lender advances money directly to the builder after each stage is completed and inspected. Common stages include slab completion, frame completion, lockup, fixing, and practical completion.

Consider an investor funding a house and land package in Mulgrave. The total build cost is approved at the loan amount set out in the fixed price building contract. After the slab is poured and inspected, the lender releases the first drawdown, typically around 15-20% of the build cost. The investor only pays interest on that portion until the next stage is completed and the next drawdown is released. This continues through each milestone until the build is finished and the full loan amount has been drawn.

Interest Charges: Only on What You've Drawn

You're charged interest on the cumulative amount drawn down, not the full loan approval. During the early stages of construction, your interest costs are lower because less of the loan has been accessed. As more stages are completed and more funds are released, the interest charges gradually increase.

In the Mulgrave example, if the first drawdown is made and no further funds are released for six weeks while framing is completed, the investor pays interest only on that initial amount during that period. Once the frame is complete and inspected, the next instalment is drawn and interest is then calculated on the combined total of both drawdowns. This feature reduces the overall interest paid during construction compared to borrowing the full amount from day one.

Interest-Only Repayments During Construction

Most construction finance includes interest-only repayment options during the build phase. Instead of making principal and interest repayments on a loan amount that hasn't been fully drawn, you pay only the interest on the current balance. This keeps your monthly costs lower while the property isn't yet generating rental income.

Once construction is complete and the property settles, the loan typically converts to a standard investment loan structure. At that point, you can choose to continue with interest-only repayments for a set period, often up to five years, or switch to principal and interest repayments. For investors, maintaining interest-only repayments after completion is common because it maximises cash flow and keeps the debt deductible.

Progress Inspections and Drawing Fees

Before releasing funds at each stage, the lender arranges a progress inspection to confirm the work has been completed to the required standard. A qualified building inspector assesses the stage and provides a report to the lender. Once satisfied, the lender releases the next instalment to the builder.

Lenders charge a Progressive Drawing Fee to cover the cost of these inspections and the administrative work involved in managing multiple fund releases. This fee typically ranges from around $800 to $1,500 depending on the lender and the number of expected drawdowns. Some lenders charge this upfront, others capitalise it into the loan. It's a cost specific to construction funding that doesn't apply to standard home loan settlements.

Fixed Price Contracts and Cost Control

Lenders require a fixed price building contract with a registered builder before approving construction finance. This contract sets out the total build cost and the progress payment schedule. It protects both the investor and the lender by locking in the price and preventing cost blowouts that could leave the project underfunded.

A cost plus contract, where the builder charges for materials and labour plus a margin, is generally not accepted by mainstream lenders for investment property construction. The fixed price structure ensures the loan amount approved will cover the full build, provided the scope of work doesn't change. Variations to the contract can trigger additional costs and may require further approval or funds from the investor.

Timeframes: When Construction Must Start

Construction loan approvals include a condition that building must commence within a set period from the disclosure date, typically six to twelve months. If construction hasn't started within that window, the approval may lapse and you'll need to reapply. This protects the lender from approving a loan based on current circumstances that may have changed significantly by the time the build actually starts.

For investors purchasing a land and construction package, this means ensuring council approval and any development application requirements are progressed quickly after the loan is approved. Delays in obtaining council plans or final permits can push the start date beyond the lender's timeframe and create complications with the finance approval.

Converting to Permanent Finance

Once construction is complete and the property reaches practical completion, the construction loan converts to a construction to permanent loan. The progressive drawdown phase ends, the full loan amount is now active, and the loan operates as a standard investment loan. The interest rate may change at this point if the construction phase was on a different rate structure to the ongoing loan.

Some lenders offer a single approval that covers both the construction phase and the ongoing loan, with the same interest rate applying throughout. Others may have a different construction loan interest rate during the build, then revert to their standard variable or fixed investment loan rate once construction is finished. Understanding how your rate will change after completion is part of assessing the true cost of the funding.

Call one of our team or book an appointment at a time that works for you. We work with lenders who offer construction finance tailored to investors, and we can walk you through the features, costs, and timing that apply to your specific build project.

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