Building a home gives you the opportunity to create exactly what you want. Whether it is your first home, a family upgrade, or an investment property, constructing from the ground up can be rewarding.

However, financing a build is more complex than buying an established property.

Unlike a standard home loan where the lender provides the funds at settlement, a construction loan releases money in stages as the build progresses. These staged payments are known as progress payments.

While this structure offers advantages, it also creates challenges that many borrowers do not fully understand until construction is underway.

Let's break down how construction loans work, how progress payments are made, and the common pitfalls that can catch borrowers off guard.

What Is a Construction Loan?

A construction loan is a home loan specifically designed to fund the construction of a new property.

Rather than advancing the full loan amount upfront, the lender releases funds to the builder at different stages of construction. This reduces risk for both the borrower and the lender because money is only released as work is completed.

Construction loans are commonly used for:

• New home builds
• Knockdown and rebuild projects
• Major renovations
• House and land packages

The lender will usually require:

• Signed building contract
• Detailed plans and specifications
• Council approvals where required
• Fixed price construction contract

Once approved, the lender establishes the maximum loan amount and schedules progress payments based on the build stages.

How Progress Payments Work

Progress payments are one of the biggest differences between a construction loan and a traditional mortgage.

Instead of receiving the entire loan amount at once, funds are progressively released as construction milestones are reached.

While stages can vary slightly between lenders and builders, a typical progress payment schedule may include:

Deposit Stage

This is generally paid when the building contract is signed.

Builders often require an upfront deposit before work begins.

Base Stage

The foundation is laid, including site preparation, excavation, slab, or stumps.

This marks the commencement of physical construction.

Frame Stage

The structural framework of the home is completed.

Walls, roof trusses, and supporting structures are installed.

Lock Up Stage

External walls, roofing, windows, and doors are completed.

At this stage the property can usually be secured and "locked up."

Fixing Stage

Internal fittings are installed.

This may include plastering, cabinetry, internal doors, and fixtures.

Completion Stage

Final works are completed and the property is ready for handover.

The lender typically performs a final inspection before releasing the last payment.

The Benefit of Interest Only Payments During Construction

One major advantage of construction loans is that borrowers generally only pay interest on funds that have been drawn down. For example, if your approved loan amount is $700,000 but only $200,000 has been used during the early stages, interest is generally charged only on that $200,000.

This can significantly reduce repayment costs while construction is underway. Once the build is completed and all funds have been drawn, the loan usually converts to principal and interest repayments.

Why Valuations Matter

Many borrowers assume the lender simply looks at the construction contract value.

Lenders often assess the projected completed value of the property before approving the loan.

This valuation considers:

• Land value
• Building plans
• Construction specifications
• Local market conditions
• Comparable property sales

If the valuation comes in lower than expected, borrowers may need to contribute additional funds to proceed. This can become a major surprise for borrowers who have budgeted tightly.

The Hidden Risk of Cost Overruns

One of the most common construction loan challenges is unexpected building costs.

Even with a fixed price contract, additional expenses can arise through:

• Site complications
• Upgraded finishes
• Landscaping
• Retaining walls
• Driveways
• Council related costs
• Builder variations

Many borrowers use every available dollar for the initial build budget and leave little room for unexpected expenses. A practical rule is to maintain a financial buffer for costs that are not included in the original contract. Construction often comes with surprises, and having additional funds available can significantly reduce stress.

Construction Delays Can Create Financial Pressure

Australia's construction industry has experienced significant delays in recent years due to labour shortages, supply chain disruptions, weather events, and rising material costs.

Delays can have financial consequences beyond inconvenience.

Borrowers may face:

• Extended rental costs
• Additional interest expenses
• Storage costs
• Delayed move in dates
• Potential contract extension fees

While many delays are outside the borrower's control, understanding potential risks beforehand allows better financial planning.

Builder Financial Stability Matters

Choosing a builder is one of the most important decisions in the entire construction process. Price alone should never be the deciding factor. Unfortunately, Australia has seen numerous builders enter financial difficulty in recent years, leaving projects delayed or incomplete.

Before signing a contract, consider:

• Builder reputation
• Financial stability
• Industry reviews
• Previous projects
• Communication quality
• Contract transparency

Taking extra time to perform due diligence can save substantial stress later.

Common Construction Loan Pitfalls

Many borrowers encounter similar issues when financing a build. Understanding these risks can help you avoid them.

Underestimating Total Costs

The construction contract is only one component of the overall project cost.

Borrowers should also consider:

• Landscaping
• Driveways
• Fencing
• Window coverings
• Moving expenses
• Utility connections

Not Allowing a Financial Buffer

Unexpected costs occur in many building projects. Having additional savings can provide valuable flexibility.

Making Too Many Variations

Upgrades and design changes can quickly add thousands of dollars to the final cost. Small decisions often compound throughout construction.

Ignoring Build Timeframes

If construction takes longer than expected, temporary living arrangements and holding costs may increase.

Choosing the Cheapest Builder

The lowest quote is not always the best value. Experience, quality, communication, and financial stability are equally important considerations.

Conclusion

Construction loans provide a flexible way to finance a new build, but they come with additional moving parts compared to a standard home loan. Understanding progress payments, lender requirements, valuations, and potential cost overruns can help you approach the overall process in a more prepared manner.

The key is preparation. The more you understand before construction begins, the better positioned you'll be to manage surprises, stay on budget, and enjoy the process of creating your new home.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

Book an obligation-free, complimentary consultation here today.

Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.