Construction Loan: How It Works and How to Apply

If you are planning a knockdown rebuild or building a new home, you will almost certainly need a construction loan. These work very differently from a standard home loan — and understanding the mechanics before you apply will save you stress and money.

What Is a Construction Loan?

A construction loan is a type of home loan designed specifically for building projects. Instead of receiving the full loan amount on settlement day, the lender releases funds in stages — called "progressive drawdowns" — as construction reaches agreed milestones.

During the construction period, you typically pay interest only on the amount drawn down, not on the total loan. Once construction is complete, the loan usually converts to a standard principal-and-interest home loan.

The Progressive Drawdown Structure

Most lenders use a 5 or 6 stage drawdown schedule aligned with your building contract:

Stage	Typical %	What It Covers
1. Deposit / Base	5–10%	Contract deposit, site preparation, slab pour
2. Frame	15–20%	Wall frames, roof trusses erected
3. Lock-up	20–25%	Roof on, external walls complete, windows and doors installed
4. Fit-out / Fixing	20–25%	Internal linings, kitchen, bathroom, electrical and plumbing fit-off
5. Completion	5–10%	Final finishes, practical completion, handover

At each stage, your builder submits a progress claim. Your lender (or their appointed valuer/inspector) verifies the work has been completed before releasing the next payment.

Interest During Construction

This is a crucial point many people misunderstand. During construction, you only pay interest on what has been drawn, not the full loan:

• After Stage 1 ($80,000 drawn): you pay interest on $80,000
• After Stage 2 ($240,000 drawn): you pay interest on $240,000
• After completion ($800,000 drawn): you pay interest on $800,000, then convert to P&I

With the RBA cash rate at 4.10% as of early 2026, construction loan variable rates are typically 6.0%–7.0%. On a $240,000 drawdown, that is roughly $1,200–$1,400 per month in interest. Budget for interest payments that increase as each stage is drawn.

Fixed Price vs Cost Plus: What Lenders Prefer

Lenders strongly prefer — and many require — a fixed-price building contract. This gives the lender certainty about the total cost and makes valuation straightforward.

If you are using a cost-plus contract, fewer lenders will approve you, and those that do will typically:

• Require a lower loan-to-value ratio (LVR) — often 60–70% maximum
• Require a larger cash contingency buffer
• Charge a higher interest rate

For most owner-occupier builds, a fixed-price contract is the path of least resistance for finance.

Deposit and LVR Requirements

The deposit you need depends on your existing equity and the project cost:

• If you own the land outright: Your land equity counts toward the deposit. Many lenders will fund up to 80% LVR of the "on completion" value — so if the completed home is valued at $1.5M and your land is worth $800K, you could potentially borrow up to $1.2M (80% of $1.5M).
• If you have a mortgage on the land: Your existing equity in the land (market value minus mortgage balance) counts toward the deposit. The lender may refinance your existing mortgage into the construction loan.
• Lender's Mortgage Insurance (LMI): If your LVR exceeds 80%, you will pay LMI — which can add $10,000–$40,000+ to your costs. Some lenders don't offer construction loans above 80% LVR.

What You Need to Apply

To get pre-approved for a construction loan, you will typically need:

1. Income documentation: Payslips, tax returns, financial statements (if self-employed)
2. Fixed-price building contract (signed or at least in draft)
3. Council-approved plans (DA or CDC approval)
4. Builder's licence and insurance certificates
5. Specifications document
6. Land title or evidence of ownership
7. Existing mortgage details (if applicable)

Many lenders will issue a conditional pre-approval based on your financials before you have finalised plans, then convert to full approval once plans and contracts are ready.

Common Pitfalls

• Not budgeting for the "gap": There is often a 2–4 week gap between your builder invoicing and the lender releasing payment. If your builder expects prompt payment, you may need to bridge this gap with cash.
• Forgetting about rent: If you are demolishing your existing home, you need somewhere to live during construction (typically 9–15 months). Budget $2,000–$4,000/month for rental.
• Variations blowing the budget: Your lender approved a specific amount. If variations push costs above the approved loan, you need to fund the difference from your own pocket.
• Interest rate rises during build: A 12-month build period means 12 months of interest rate risk on a variable loan. Ask your broker about fixing the construction loan rate if stability matters to you.

Tips for a Smooth Application

• Use a mortgage broker who specialises in construction loans — they know which lenders are builder-friendly and which have efficient drawdown processes
• Get pre-approved before signing a building contract — you don't want to sign a $700K contract only to find your borrowing power is $500K
• Keep a cash buffer of at least $30,000–$50,000 above the loan amount for variations and unexpected costs
• Compare not just interest rates but drawdown turnaround times — some lenders take 2 days, others take 2 weeks. Slow drawdowns frustrate builders and can delay your project.

Next Steps

Start by understanding what your block and project would cost. Use the free feasibility check at AusBuildCircle.com to get an estimate, then take that to a construction-specialist broker for pre-approval.