5 things you need to know about home construction loans

If you’re planning to build your own house or buy into a brand-new development, there are a few things you need know about financing the construction of your new build.

1. How much deposit will I need for my new build?

If you’re applying for a home loan (established property and land), you’ll normally need a deposit of 20% of the purchase price – or 35% if you’re buying an investment property rather than a home for yourself.

For a new property, the rules are different – new developments are not subject to the Reserve Bank of New Zealand’s LVR rules:

So you may be able to get a new build mortgage (also known as a ‘construction loan’) even if you only have a deposit of just 5%.

That’s not guaranteed, though – lenders generally only offer low-deposit loans to borrowers with the strongest credit scores, and you’ll need to meet other important criteria, especially serviceability (your capacity to repay your loan).

Be aware, too, that a smaller deposit means a larger loan. Saving a bigger deposit and borrowing less will save you a huge amount of interest in the long run.

2. Is there room for negotiation?

The home loan market is highly competitive, so there’s almost always room for negotiation!

The key to getting a good deal on your construction loan is to shop around. When making comparisons, be sure to look at fees, terms and conditions and special deals (like cash back offers or free legal fees), as well as interest rates.

With so many lenders and products on the market it can be confusing working out which mortgage is right for you. An experienced broker can help you understand what’s available and choose a loan to suit your circumstances.

3. Should I pay for my new home in instalments?

Financing a new build can be a real minefield, and there’s no easy answer to this question.

One thing is certain: paying a large deposit before building even begins is never a good idea. The construction industry is notorious for delays – and why should your hard-earned cash be used to finance other projects while you’re stuck waiting ground to be broken on your new home?

The real question is how to finance your home during construction – should you make progress payments, or pay at the end?

The newspapers will show you that there’s always a risk of your builder going bust, leaving your precious new home half-built, which may well discourage you from paying in instalments.

Some builders will offer a ‘turnkey’ contract, which means that you won’t pay for your new home until you collect the keys on the finished building. You’ll still have to pay a deposit to secure the property, but this may be held in escrow by the lawyers during construction.

But turnkey contracts aren’t always available, and they do have their drawbacks – since there’s a big gap between agreeing to the purchase and paying for it (usually six to nine months), there’s a risk that your lender will withdraw finance before the house is completed.

How can this happen? Well, a home loan offer is usually valid for 60 –
90 days, after which you’ll need to reaffirm your financial position. If your circumstances change during construction, your bank could pull the funding and leave you with a contract you can’t fulfil.

This conundrum is enough to put many people off building altogether – but don’t despair, very few new builds end in disaster! Be sure to take proper legal advice (essential) and get a good mortgage broker on your team to help you structure your purchase and finance appropriately.

4. How do I manage financially during construction?

While your new home is being built, you still need somewhere to live.

Unless you plan on living in a caravan whilst your home is being built!

So how do you manage paying the rent or mortgage on the place you’re living in, as well as interest on your construction loan and land, during the long months of construction?

You may have enough cash to spare, of course – or have a kindly friend or relative you can live with during the build. But if not, there’s a real risk that a lender may turn down your mortgage application for just this reason – your inability to service both financial obligations at once.

This might be another argument in favour of a turnkey contract, since you won’t draw down the loan and start paying interest until construction is complete.

Another possibility, if you have an experienced broker on your side, may be to negotiate with the lender and have the interest for the construction period deferred and added to your loan balance. (Note: if you do this, you’ll end up paying interest on the interest!)

5. Can I use income from my current property to finance my new build?

If you own your own property and plan to either sell or rent it out later to help finance your new home, there are a couple of issues you might run into.

  • Rent can be a great income stream, but lenders probably won’t be willing to take it into account when assessing your application if it’s only prospective.

    If you can’t afford to pay your mortgage without it, you may have to move out of your home and rent it out, in order to secure that steady source of income before you apply.

  • If you’re planning to sell your home to finance a portion of the purchase, you may have a timing problem unless you move out and sell your current home before construction is finished on your new build.

    To resolve this problem, you may be able to arrange bridging finance – and if your home loan lender is not willing to consider this, you could turn to an alternative funding source. This is likely to be an expensive option, though, so be sure to get guidance and a cost-benefit analysis from an experienced mortgage broker.

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