Construction Loans? - Are they an option?

Banks across Australia, particularly the smaller ones, have become dependent on construction loans just as that area of the economy is weakening and the number of bad loans is growing.


Construction loans soared and now problems are growing. Figures released last week show that both midsize and small banks had construction loans outstanding that were greater than their total capital. A decade ago, such loans were equal to only a third of capital for those banks. For most of this decade, that was a good strategy. Construction loans proved to be very profitable, particularly for smaller banks as competition from larger banks and securities markets eroded their position in areas like mortgage lending and credit card issuance.

Now, however, more than 3 percent of all construction loans are classified as being nonperforming, or have borrowers that are behind on their payments. That is the highest proportion in a decade.

Disadvantages of Construction Loans

When construction loans go bad, they can go very bad, in part because it can take a long time to slow them down after markets begin to weaken. Construction projects, once begun, are useless if not finished.

It is somewhat easier to slow spending on single-family homes, since a developer planning a 50-home project can leave some of the homes unbuilt if demand dries up. But a planned 20-story block of units cannot be topped off after 10 floors are built.

In early 1991, in the last big real estate downturn, the percentage of construction loans that were either on nonperforming status or behind in payments hit 18.5 percent, nearly six times the current level.

For anything like that to happen now, commercial real estate markets — including office buildings and stores — would have to weaken significantly.

House-and-land packages have been a popular choice for many first homebuyers, especially in the outer metropolitan areas of Sydney where land is still affordable. The ability to customise your dream home makes it even more appealing to many Australians.

Because the exercise is done in stages – paying a deposit or paying in full for the land, commissioning a builder who requires payments at certain stages such as laying a concrete slab, roofing the frame etc. – lenders have tailored a home loan to suit.

A construction loan is similar to any other mortgage banks and brokers offer with the major difference being in the way the loan is used or drawn-down.

Instead of making one full withdrawal from your lender to finance a property, a construction loan gives the borrower access to funds in small, lump sums at various intervals to suit building stages.

If you’re in the fortunate position of being able to call on existing equity in a property to finance a building project, a revolving line of credit would likely be the first choice of finance. However, the majority of borrowers would rely on a construction loan.

Advantages of Having a Construction Loan

Financing a property development with a normal mortgage would be impossible for the simple reason that the lender doesn’t have enough security on the property. Building on a block of land increases the value of the property and lenders may then be able to offer you more.

During the construction stages, your lender may revalue the property to ensure they have enough security to cover them if you default on your loan. Typically, building insurance is a requirement set by your lender for a construction loan.

Points to consider

As with any loan there are specific questions you need to check off with your lender.

There may be some costs involved when making a progressive draw-down.

Normally, lenders offer a number of free draw-downs but you may be liable for extra cost if you exceed this limit.

Think about your own personal requirements and choose a loan to fit with that. There’s a wide variance in the marketplace – some products offer an unlimited amount of draw-downs while others might charge fees of up to $240 per draw-down.

When building a house the length of construction period can become an issue. It’s important to check with your lender how they deal with the unexpected – such as a rain delay in construction. Some lenders will still allow you to continue drawing down funds but others will cap the period of time allowed before you must take the full amount of the loan.

Where to start shopping?

It’s not difficult to find a construction loan, as it is very similar to a normal mortgage. Most lenders have this construction feature with their variable rate loan. To find out how The Mortgage Bureau can assist you in your Construction Loan, please contact us via the details below:

Contacting The Mortgage Bureau

Paul Neary

Phone: 02 9629 1888

Fax: 02 9836 4058

Mobile: 0404 011 171
Email: paul@tmbhills.com.au