Construction finance for a custom home works differently to a standard mortgage because you're funding a project that doesn't exist yet.
When you purchase a custom home project, the lender releases funds in stages as your registered builder completes specific milestones. You only pay interest on what's been drawn down, not the full loan amount, and the approval process considers both the land value and the proposed building contract. Understanding how progressive drawdowns align with your building contract, what lenders look for in a custom home application, and how repayments work during construction will determine whether your project proceeds smoothly or stalls at the first progress payment.
How Construction Finance Differs from Standard Home Loans
A construction loan releases funds progressively as building milestones are completed, rather than providing the full amount upfront. During the building phase, you typically make interest-only repayments on the amount drawn down so far. Once construction finishes and you receive the certificate of occupancy, the loan converts to a standard principal and interest home loan.
Consider a buyer purchasing land for $250,000 with a fixed price building contract of $450,000. The lender approves the full $700,000 construction facility, but initially only releases funds to settle the land purchase. As the builder completes the slab, frame, lockup, fixing, and practical completion stages, the lender disburses additional instalments. If $400,000 has been drawn after the lockup stage, you're only charged interest on that $400,000, not the full loan amount. Once the home is complete and you move in, the loan converts to a standard mortgage with principal and interest repayments on the total amount drawn.
Most lenders charge a Progressive Drawing Fee, typically between $200 and $400 per drawdown, to cover the cost of having a quantity surveyor or valuer inspect the property at each stage. This fee applies every time the builder requests a progress payment, usually five or six times during the build.
What Lenders Assess in a Custom Home Application
Lenders evaluate both your financial position and the viability of the building project itself. They'll assess your income, existing debts, deposit size, and credit history as they would for any home loan, but they also scrutinise the building contract, site suitability, and builder credentials.
You'll need a fixed price building contract from a registered builder with appropriate insurance. Lenders won't approve cost plus contracts for residential construction finance because the final build cost remains uncertain. The contract must detail the scope of works, total price, and progress payment schedule. Your builder needs to hold valid registration in the state where you're building, along with home warranty insurance that covers the contract value.
The lender will also confirm that council approval or a development application has been lodged and that the site has no unusual constraints. If you're building on sloping land requiring significant earthworks, or on a block with easements or heritage overlays, the lender may request an engineer's report or reduce the amount they're willing to lend. Suitable land with straightforward access, services connected, and no unusual site conditions makes approval more likely.
How the Progressive Drawdown Schedule Works
The progress payment schedule in your building contract must align with the lender's drawdown stages. Most construction loans release funds in five or six instalments tied to physical completion milestones: base stage (slab or stumps), frame stage, lockup (roof and windows installed), fixing stage (plumbing and electrical roughed in), practical completion, and final completion.
Your builder submits a payment claim when each stage is finished. The lender arranges a progress inspection, usually conducted by a valuer or quantity surveyor, to confirm the work has been completed to the required standard. Once the inspection report is received and approved, the lender releases the funds directly to the builder, minus the Progressive Drawing Fee. This process typically takes five to seven business days from when the builder lodges the claim, so timing matters if your builder has sub-contractors waiting for payment.
Some lenders allow you to hold back a small percentage, often five percent, until final completion when any defects have been rectified. This retention amount gives you leverage if minor issues arise during the defects liability period, though not all construction loan products include this feature.
Managing Repayments During the Building Phase
Most construction loans offer interest-only repayment options during the building period, typically capped at 12 or 18 months. You only pay interest on the amount drawn down so far, which keeps repayments lower while you're potentially still paying rent or a mortgage on your current home. As each progress payment is released, your repayment amount increases to reflect the new balance.
If the land settlement draws down $250,000 and the first progress payment for the slab releases another $80,000, your interest-only repayment is calculated on $330,000. After the frame stage, if another $120,000 is drawn, your repayment adjusts to reflect the new balance of $450,000. This incremental approach means your repayments gradually increase rather than jumping to the full amount immediately.
Some borrowers maintain their existing rental or mortgage payments throughout construction and treat the construction loan interest as an additional cost. Others sell their current property early in the build and move into temporary accommodation to free up equity. Your borrowing capacity needs to cover both the construction loan repayments and any ongoing housing costs during the build, so lenders assess your ability to service the loan at the full amount, not just the initial drawdown.
Fixed Price Contracts and Builder Selection
Lenders require a fixed price building contract because it establishes a clear maximum loan amount and protects both you and the lender from cost blowouts. The contract should specify exactly what's included, from site preparation and footings through to floor coverings and landscaping. Variations requested after signing increase the contract price and may require additional borrowing, so understanding what's covered before you sign avoids surprises later.
Your registered builder must hold the appropriate licence category for the work being undertaken and provide evidence of home warranty insurance before the lender will approve the loan. In most states, builders are required to hold insurance covering residential building work over a certain value, typically $20,000. This insurance protects you if the builder becomes insolvent or fails to rectify defects.
If you're planning to act as an owner builder, construction loan options become more limited. Some lenders won't provide owner builder finance at all, while others impose stricter conditions, lower loan-to-value ratios, and higher interest rates. You'll need to demonstrate relevant building experience, provide detailed costings for every trade, and often accept a lower loan amount than if you were using a registered builder.
When You Must Commence Building
Most construction loan approvals require you to commence building within a set period from the disclosure date, typically six months. If you settle on the land but delays occur with council plans, site preparation, or builder availability, and construction doesn't start within that window, the approval may lapse. You'll need to reapply, and if your financial circumstances have changed or lending policies have tightened, you may no longer qualify under the same terms.
This timing requirement exists because lenders base their approval on the current property valuation, your current financial position, and the building contract price. If 12 months pass before construction starts, land values may have shifted, your income or employment might have changed, and the builder's quote could have expired. Starting promptly protects both your approval and your fixed price building contract.
If you're purchasing land and arranging construction finance simultaneously, coordinate settlement of the land with your builder's availability. Holding land for months before starting construction ties up capital and may push you beyond the lender's commencement deadline, particularly if the builder is managing other projects and can't schedule your build immediately.
Construction Loan Interest Rates and Loan Structures
Construction loan interest rates are typically comparable to standard variable home loan rates, though some lenders add a small margin during the construction phase. Once the build completes and the loan converts to a standard mortgage, the rate usually matches the lender's owner-occupied or investment loan rates depending on how you'll use the property.
You can often split your construction loan into fixed and variable portions, or choose to fix the rate once construction is complete and the loan converts. Fixing during construction is less common because the loan balance is increasing progressively, making it harder to lock in a rate on an amount that hasn't been fully drawn yet. Most borrowers remain on a variable rate during the build and then decide whether to fix part or all of the loan once they've moved in.
Some lenders require a higher deposit for construction finance than for purchasing an established home, often 10 or 15 percent rather than five percent. This reduces the lender's risk given the loan is secured against an incomplete asset during the building phase. If you're purchasing a land and construction package and can only provide a five percent deposit, your options may be limited to a smaller number of lenders who accept higher loan-to-value ratios for this type of finance.
What Happens if the Build Runs Over Time or Budget
If your builder encounters delays due to weather, supply chain issues, or labour shortages, your construction loan remains active but you'll continue paying interest on the amount drawn for longer than anticipated. Most lenders allow 12 months for construction, with the option to extend if needed, though extensions may incur additional fees or require updated valuations.
Cost overruns are more serious because they can leave you without enough funds to complete the build. If unexpected site conditions require additional earthworks or the builder identifies variations not covered in the original contract, you may need to increase your loan amount. This requires a new application, updated valuation, and confirmation that you can service the higher debt. If the lender declines the additional funding, you'll need to cover the shortfall from savings or delay construction until you can source alternative finance.
A fixed price building contract minimises this risk because the builder is contractually obligated to complete the home for the agreed price, even if their costs increase. Variations you request, such as upgrading fixtures or adding features not in the original plan, increase the contract price and need to be funded separately. Keeping variations minimal during construction avoids the need to revisit your finance halfway through the project.
Building a custom home involves coordinating land purchase, builder contracts, council approvals, and progressive funding across a timeline that can stretch 12 months or more. Understanding how construction finance works before you commit to a building contract helps you avoid funding gaps and costly delays. Call one of our team or book an appointment at a time that works for you.
Frequently Asked Questions
Do I pay interest on the full construction loan amount from the start?
No, you only pay interest on the amount drawn down so far. As each progress payment is released to your builder, your interest repayments increase to reflect the new balance.
Can I use a cost plus contract for construction finance?
Most lenders won't approve cost plus contracts for residential construction because the final build cost isn't fixed. You'll need a fixed price building contract with a registered builder to qualify for construction finance.
How long do I have to start building after the loan is approved?
Most lenders require you to commence building within six months of the approval or disclosure date. If construction doesn't start within that period, the approval may lapse and you'll need to reapply.
What happens if my build goes over budget?
You'll need to apply for additional funding, which requires a new assessment and updated valuation. If the lender declines, you'll need to cover the shortfall from savings or find alternative finance to complete the build.
Are construction loan interest rates higher than standard home loans?
Construction loan rates are typically comparable to standard variable rates, though some lenders add a small margin during the building phase. Once construction finishes, the loan converts to a standard mortgage at the lender's usual rates.
