In the context of a house and land package acquisition, we need to look at the land acquisition followed by the construction loan. They can be done separately but it makes a lot more sense to organise them together to give the purchaser certainty about obtaining finance.
Most lenders offer products that cater for house and land packages.
How does financing work when it comes to building a new property? How does it differ to financing for established properties?
Financing a house and land package is usually done in 2 steps:
Step 1: Acquisition of land.
Step 2: Construction of the house.
Essentially a construction loan is a variable loan where funds are drawn down in stages based on the progress of the construction. Typically there are 4 or 5 drawdowns and typically these are:
The difference with financing an established property lies in the 2-step process described above and the progressive drawdown of the construction loan. In financing an established property, there is only a single transaction.
Also, note that during the construction period the loan is interest only. Once completed this will revert to principal & interest repayments unless the buyer initially applied for an interest only period.
Finally, although it is not directly finance related, stamp duty is much cheaper on a house and land package acquisition compared to an established property, because stamp duty applies to the land component only. This can save tens of thousands of dollars from the acquisition costs. Also, depreciation is maximised as the house is new and therefore cash flow is much better. This makes a house and land package quite attractive in the current market.
Let’s look at the 2 steps from a lender’s point of view:
In a nutshell, when financing a house and land package, a bank/lender will initially require:
This will allow the lender to organise a valuation of the property as if it was completed, even though it does not yet exist. Once satisfied, the bank/lender will formally approve the whole package.
Detailed analysis of a land and construction loan
STEP 1: Land Acquisition
All parties then concentrate on settling the land first.
For land settlement, banks will require more documents such as land titling, which the conveyancer or mortgage broker usually organises.
Banks will then work out settlement amounts.
Did you know?
When calculating how much they will lend to a buyer, banks will look at the whole package and will require the buyer to contribute their share of the whole financing at land settlement. As an example, if the package is $400,000 ($150,000 land and $250,000 house) and the buyer borrows 80% overall, the bank will expect the buyer to contribute the other 20% (ie $80,000) when the land settles. In this case the bank will make $70,000 available for the $150,000 land settlement and the buyer will have to contribute the rest ($80,000 + stamp duty if applicable + fees).
The good news is that the bank will then pay for 100% of the construction drawdowns, so that the end position is 80% borrowed, 20% buyer contribution (plus costs).
STEP 2: Construction loan
The bank/lender will then turn to the construction.
Before the first drawdown is approved, a bank will ensure that all council approvals are in place, that the builder has the relevant insurance, etc.. Once they are happy that all the paperwork is in order, they will certify the file as ready for drawdown.
What are the most important things to consider with construction finance?
As explained above, financing a house and land package is a bit more intricate than a standard loan. Therefore, use a broker who is competent with these products! There is a vast array of construction loans out there with many different quirks, and limiting yourself by going directly to a bank is not the best way to do it. Also keep in mind the following:
Do most banks and lenders offer construction loans?
Most of the banks and lenders offer construction loans, as a construction loan is essentially a variable loan with drawdown features.
Overall, there are great deals for constructions loans in the market place. A buyer (or broker if one is used) needs to do a bit more researching than for standard loans as they are more intricate.
What should first time buyers be cautious of when financing a new property?