Building a new home is exciting, and financing one is more complicated than buying an established property. A construction loan works fundamentally differently from a standard mortgage, and understanding how it works before you sign anything can save you from some very expensive surprises.
This guide explains exactly how construction loans operate, what the risks are, and how to protect yourself through the build.
What Is a Construction Loan?
A construction loan is a specialist home loan that releases funds progressively as your home is built, rather than all at once at settlement. This is necessary because until the home is complete, there's no property for the lender to take as security in the traditional sense. The lender is lending against the land plus the future value of the completed structure.
The key differences from a standard home loan:
- Funds are drawn in stages, not as a lump sum
Most lenders offer construction loans for owner-occupied builds and investment builds, though the products and conditions differ.
The 5 Progress Draw Stages
Lenders typically fund a construction loan in five progress draws that correspond to key milestones in the build. The builder invoices at each stage, and you (or your solicitor) submit a draw request to the lender. The lender releases funds directly to the builder after inspecting or confirming the milestone is complete.
Stage 1: Base / Slab (10–15% of contract price)
The first draw is released once the foundations or concrete slab are poured. This is typically 10–15% of the total building contract, covering earthworks, formwork, steel, and the slab pour itself.
Stage 2: Frame (20–25% of contract price)
Once the timber or steel frame is erected and inspected by a building certifier, the second draw is released. At this stage your home starts to look like a structure. The frame inspection is a critical quality checkpoint.
Stage 3: Lock-Up (20–25% of contract price)
Lock-up means the home is weather-tight: external walls, roof, windows, and external doors are in place. The structure is "locked up" so internal work can begin without weather exposure. This is often the largest single draw.
Stage 4: Fixing (20–25% of contract price)
Fixing covers all the internal fittings: plasterboard, internal doors, kitchen cabinetry, bathroom tiling, flooring, and the rough-in of electrical, plumbing, and HVAC. The home starts to look finished internally at this point.
Stage 5: Practical Completion (10–15% of contract price)
The final draw is released when the builder has completed all work and issued a certificate of practical completion. This is when you do your final inspection walkthrough. Any defects identified should be documented for the defects liability period (typically 6–12 months after handover).
Important: The exact percentages vary by builder and state. Your building contract will specify the amounts. Confirm these align with your lender's approved draw schedule before signing.
Interest Only During Construction
During the construction period, you only pay interest on the funds that have actually been drawn down, not on the full approved loan amount. This keeps your repayments manageable while you're building, which is particularly useful if you're also paying rent at the same time.
For example, if your loan is approved for $600,000 but only $120,000 has been drawn after Stage 1 and Stage 2, you're only paying interest on $120,000. As each subsequent draw is made, your interest bill increases accordingly.
This interest-only period is temporary. Once practical completion is reached and the final draw has been released, the loan typically converts to a standard principal and interest loan on your agreed interest rate.
How Valuations Work During a Construction Loan
Before the lender approves your construction loan, they order a progress valuation: an assessment of the land value plus the projected end value of the completed home, based on the building contract. This is called an "on completion" valuation.
If this valuation comes in lower than the contract price, you have a problem: the lender will calculate your LVR based on the lower figure, which may mean you need a larger deposit or additional funds.
Some lenders also conduct inspections at each draw stage to confirm the work has been completed before releasing funds. Others rely on the builder's invoice and a self-certification. Lenders who actively inspect at each stage offer better protection against progress payment disputes.
The Real Risks of Construction Loans
Building is inherently more complex than buying established. Here are the risks you need to understand before you start:
Builder Delays
Construction delays are common: weather, labour shortages, material supply issues, and the builder taking on too many projects all contribute. Delays extend the construction period, meaning you're in the interest-only phase longer and potentially paying rent for longer. Build timeline buffers into your financial planning.
Variations and Cost Overruns
If you change your mind about a kitchen layout, add a window, or upgrade your inclusions after the contract is signed, you'll be charged a variation. Variations can add up quickly, and they're not included in your original approved loan amount. You'll need cash to cover variations unless you negotiate a contingency amount with your lender at the outset.
The golden rule: Get everything you want in the original contract. Every change after signing costs you.
Builder Insolvency
Builders occasionally go into administration mid-build. Queensland requires builders to hold QBCC Home Warranty Insurance for residential contracts over $3,300. This provides protection if your builder goes insolvent, dies, or disappears, though claims take time and may not cover 100% of your loss. Verify your builder's QBCC licence and insurance before signing anything.
Valuation Shortfalls at Completion
If the final valuation comes in below the total cost of land plus construction (which can happen in certain markets or if you've made expensive variations), your lender may restrict your final draw. Have a conversation with your broker about this risk before you commit.
Why the Fixed Price Contract Is Non-Negotiable
Lenders require a fixed price building contract, not a cost-plus arrangement. A fixed price contract specifies the total amount payable for the completed home, giving the lender certainty about what they're funding.
Cost-plus contracts, where you pay the builder's costs plus a margin, introduce too much uncertainty for a lender to assess. If your builder won't provide a fixed price contract, that's a significant red flag.
Ensure your contract includes:
When the Build Is Complete: Loan Conversion
Once your builder issues the certificate of practical completion, your lender converts the construction loan to a standard home loan. At this point:
If you've drawn less than the full approved amount (because the build came in under budget), the unused portion is closed off and you only service the amount actually used.
Choosing the Right Lender for a Construction Loan
Not all lenders handle construction loans well. Some major banks have slow draw-down processes, inconsistent valuers, or rigid stage payment schedules that don't match your builder's invoicing. A poor lender can hold up progress and create tension with your builder.
When assessing construction lenders, look for:
This is one area where a broker who has lodged construction loan applications before can make a real difference. They'll know which lenders are genuinely easy to work with and which are theoretically fine but operationally painful.
Key Tips Before You Sign Anything
Ready to Finance Your Build?
Construction loan applications have more moving parts than standard home loans, and the right guidance from the start can save you significant stress. Tom Smith at Kookaburra Finance has experience with house-and-land packages and custom builds across South East Queensland.
Book a free call to discuss your build plans and get clear on your financing options before you commit to anything.