How a Construction Loan Works: What Every Homebuyer Needs to Know

Securing a construction loan in Canberra is an essential step in bringing your dream home to life. With multiple stages of financing and progress payments tied to the building process, it’s important to fully understand how a construction loan works. 

Thankfully, experienced mortgage brokers can simplify the entire process. They can help you choose the right loan product, ensure your paperwork is in order, and negotiate competitive rates with lenders. 

Now, let’s break down the details of how a construction loan works and what you can expect during each step. With the right financial planning, your dream home could be just around the corner!

What is a Construction Loan?

A construction loan is a short-term loan used to finance the building of a home or major renovation project. Unlike a regular home loan (or traditional mortgage), construction loans are disbursed in stages, also known as progress payments or progressive drawdowns, which align with the phases of the construction process.

In essence, the bank doesn’t release the entire loan at once. Instead, it makes payments to the builder as specific stages of the project are completed, ensuring that money is only paid out for work that’s already done. This structure is crucial for protecting both you and the lender throughout the construction process.

Canberra Property Market Trends 2025: What They Mean for Construction Loan Home Buyers

In 2025, the Canberra property market is showing signs of sustained growth, with a focus on new home builds as land releases in the outer suburbs continue to expand. According to CoreLogic, Canberra’s property prices have increased by about 4% year-on-year, and with rising demand for housing, this trend is expected to persist.

This steady increase in property values makes now an ideal time for homeowners to consider construction loans. With the flexibility to pay in stages as your home is built, construction loans offer a smart way to finance new builds or major renovations while capitalising on Canberra’s rising property values.

Moreover, with ongoing government incentives like the ACT’s Home Buyer Concession Scheme, buyers can reduce upfront costs, making it easier to secure financing for a construction loan. Given the growth of the market and these benefits, now is the perfect time to explore building your home in Canberra with a construction loan.

Types of Construction Loans

There are various types of construction loans, and it’s essential to know which one suits your needs:

Construction-to-Permanent Loan 

This starts as a construction loan but converts into a permanent mortgage once the building process is complete. It’s a popular option because you avoid having to go through two separate loan processes.

Construction-Only Loan 

This loan only covers the building phase. Once construction is done, you’ll need to apply for a regular mortgage (traditional home loan) to pay off the balance of the construction loan.

Owner-Builder Construction Loan 

If you plan to act as your own builder (rather than hiring a licensed contractor), you may qualify for this type of loan. However, lenders often have stricter requirements for owner-builders, including proof of experience and additional documentation.

Renovation Loans 

These loans are designed for homeowners who want to finance a major renovation. The loan amounts are typically based on the projected value of the home after renovations.

Progress Payments and the Building Process

Progress payments (or progressive drawdowns) are crucial when it comes to construction loans. As mentioned, the lender releases funds in stages, which typically align with major milestones in the stages of construction. Here's a common breakdown:

• Stage 1: Foundation – The loan will cover the cost of site preparation, foundation laying, and other preliminary work.
• Stage 2: Framing – Once the walls, windows, and roof are in place, the next payment is released.
• Stage 3: Lock-Up – After the house is "locked up" (meaning doors, windows, and external cladding are installed), you’ll get the next drawdown.
• Stage 4: Fixing – This stage involves interior fittings, such as cabinetry, plumbing, and electrical work.
• Stage 5: Completion – The final payment is made after a final inspection and when the project is fully complete.

Tip: Before signing a building contract, ensure the progress payment schedule aligns with your lender’s policy. Some contractors may request more upfront, which can lead to financing complications.

How Interest Rates Work During the Construction Phase

Unlike a standard home loan, construction loans operate a bit differently when it comes to interest and repayment schedules. So, let’s break it down.

During the construction phase, most lenders offer interest-only repayments, meaning you’ll only be paying interest on the funds drawn down for each stage of construction. This helps keep your payments lower while the build is in progress, offering some financial breathing room until the home is complete.

Sample Breakdown

Let’s say you have a $400,000 construction loan, and your lender charges 5% interest annually. Here’s how your interest might work across different stages of the build:

• Stage 1: Foundation ($80,000)
  Interest on $80,000 at 5% = $4,000 annually, or $333 per month.
• Stage 2: Framing ($120,000)
  Interest on $200,000 total at 5% = $10,000 annually, or $833 per month.
• Stage 3: Lock-Up ($100,000)
  Interest on $300,000 total at 5% = $15,000 annually, or $1,250 per month.
• Stage 4: Completion ($100,000)
  Interest on $400,000 total at 5% = $20,000 annually, or $1,666 per month.

As you can see, interest payments increase progressively as more funds are drawn down for each construction stage.

Once the build is finished, the loan will typically switch to principal and interest repayments, much like a regular mortgage. At this point, you’ll begin paying down both the loan balance and any remaining interest.

This interest-only structure during the construction phase offers significant relief, especially while juggling other expenses related to the building process. 

Requirements for Getting a Construction Loan in Canberra

Securing a construction loan in Canberra requires a bit more documentation and planning than a traditional home loan. Lenders want to ensure that the project will be completed on time and within budget and that you have the financial capacity to cover the costs. 

Below are the key requirements you'll need to meet to qualify for a construction loan:

1. Strong Credit History

Just like with any other loan, a solid credit score and credit history are essential. Most lenders will look for a score of 600 or higher, but the stronger your credit, the better the terms and rates you’ll be offered.

2. Proof of Income and Financial Stability

Lenders will require documentation of your income, typically through:

• Recent pay slips
• Tax returns
• Bank statements
  

They'll also assess your debt-to-income ratio to ensure you can comfortably manage the loan repayments, both during and after the construction phase.

3. Building Contract and Detailed Plans

You’ll need to submit a fixed-price building contract from a licensed builder. This document outlines the total construction costs, timelines, and specific details of the build. Additionally, you must provide:

• Architectural plans
• Council approvals
• Construction plans
  

The more detailed your plans, the smoother your loan approval process will be.

4. Deposit and Loan-to-Value Ratio (LVR)

Most lenders will require a deposit, usually around 20% of the total loan amount. Your loan-to-value ratio (LVR) must typically be 80% or lower to avoid Lenders Mortgage Insurance (LMI), though some lenders may still accept a lower deposit with LMI.

5. Property Valuation

A property valuation is conducted to estimate the value of the land and the completed home. Lenders will compare this valuation against your total loan amount to ensure they are not lending more than the final property value.

6. Licensed Builder

Most lenders will only approve loans where the build is carried out by a licensed and insured builder. If you plan to act as an owner-builder, be prepared for stricter lending criteria and potentially higher deposit requirements.

Case Study: Sarah and Michael’s Construction Loan Journey in Canberra

Background: Sarah and Michael, a young couple from Canberra, wanted to build their dream home in Denman Prospect. With no experience in construction loans, they needed help navigating the process.

Challenges:

1. Understanding Construction Loans: They didn’t know how progress payments worked or how to handle a loan that transitions from interest-only during construction to principal-and-interest after completion.
2. Choosing a Lender: They needed a lender with good rates and flexibility, particularly one familiar with Canberra's property market.
3. Unexpected Costs: Concerned about potential cost overruns, they wanted to be financially prepared for surprises.

Solution:

1. Mortgage Broker: A local broker guided them through the process, helping them choose the right loan and lender while explaining the importance of a fixed-price contract.
2. Contingency Fund: They set aside a 10% contingency for unexpected costs, which came in handy when foundation issues arose.

Outcome: Sarah and Michael secured a $600,000 construction loan with interest-only payments during the build. Their broker managed the progress payments, and after 12 months, their home was completed on time and within budget.

They transitioned to a regular mortgage with principal-and-interest repayments, avoiding major financial stress thanks to careful planning.

FAQs

How do repayments on a construction loan work?

During the construction period, repayments are typically interest-only, with interest charged only on the funds drawn down. Once the build is complete, the repayment type shifts to principal and interest over the loan term.

What deposit is required for a construction loan?

Most construction home loans require a deposit of around 20%, though some lenders may accept less with additional costs like Lenders Mortgage Insurance. The exact amount depends on the construction loan lender and your financial situation.

How many stages are in a construction loan?

A typical construction loan is divided into five stages: foundation, framing, lock-up, fixing, and completion. Payments are made to the builder after each phase, ensuring building costs are covered as the project progresses.

How long do construction loans take to approve?

Approval for a construction loan application can take anywhere from a few days to several weeks, depending on the lender and complexity of the project. Factors like construction loan rates, the builder’s contracts, and council approvals can affect the timeline.

Can I use land equity to build a house?

Yes, you can use land equity loans to finance the construction of a house. The value of your land can serve as a deposit or reduce the loan amount needed to cover building costs.

Can you move in after practical completion?

You can move in after practical completion, once the builder has finished all agreed-upon work. However, you may still need to finalise additional costs like landscaping or finishing touches not covered in the initial contract.

Conclusion: Ready to Build?

Building your dream home in Canberra is a rewarding journey, and understanding how construction loans work is a key part of the process. With the right loan, careful planning, and the support of experienced professionals, you can confidently move through each stage of the construction period. 

If you're ready to take the next step or need expert advice, don’t hesitate to contact Home Loan Broker Canberra or call 02 6173 6397. Our team is ready to help you find the best loan for your build!