How Do Construction Loans Work? Full Guide 2026
Building your own home sounds straightforward until you ask how the money actually moves. A standard home loan hands over one lump sum at settlement. Construction finance does not work that way at all, and the difference changes how you budget, what you repay each month, and how much the whole thing costs.
The short version is that the lender releases funds in stages as the build progresses, and you pay interest only on what has been released so far. This guide covers the full process, from the first drawdown through to the moment the loan turns into an ordinary mortgage, along with the parts that catch people out.
Key takeaways
- Funds are released in stages matched to building milestones, not as one upfront payment.
- You pay interest only on what has been drawn, which on a typical build can be less than half the interest on a fully drawn loan.
- Lenders assess against the on completion valuation, not the land value or the contract price alone.
- Lenders mortgage insurance applies above 80 per cent of that completed value, not above 90 per cent.
- Most builds run one to three years before the loan converts to principal and interest.
What a Construction Loan Is and How the Money Flows
A construction loan funds the building of a home and releases the money in stages rather than all at once. That staged structure is the whole difference. Instead of handing over the full amount at settlement, the lender pays out set portions, called drawdowns or progress payments, as your builder reaches agreed milestones.
Before releasing each payment, the lender arranges an inspection or a progress valuation to confirm the work actually matches what has been claimed. That step does three things at once:
- It stops money being drawn for work that has not happened.
- It gives you an independent read on whether the builder is tracking to plan.
- It keeps the lender's exposure in line with the value actually built.
Land first, then the build
If you are buying land and building on it, the land usually settles first and is drawn in full, because you have to own the block before anyone can build on it. The construction portion then draws down in stages on top. Some lenders will settle land and construction under one approval, others treat them as two steps. It is worth confirming which, because it changes when your repayments start.
The Payment Stages, and What Each One Is Worth
In Victoria the maximum a builder can claim at each stage is set by law under the Domestic Building Contracts Act, which is useful to know because it tells you what a normal payment schedule looks like. For a contract covering all stages of a build, the caps are these.
| Stage | Maximum share of contract price | On a $450,000 build | Drawn to date |
|---|---|---|---|
| Deposit | 5% | $22,500 | $22,500 |
| Base | 10% | $45,000 | $67,500 |
| Frame | 15% | $67,500 | $135,000 |
| Lock-up | 35% | $157,500 | $292,500 |
| Fixing | 25% | $112,500 | $405,000 |
| Completion | 10% | $45,000 | $450,000 |
Two things stand out. Lock-up is the biggest single payment, so that is the point at which your interest bill steps up sharply. And the deposit is capped at 5 per cent for any contract of $20,000 or more, so a builder asking for 10 or 20 per cent up front on a full build is asking for something the law does not allow in Victoria.
These caps are Victorian
Other states and territories regulate progress payments differently, and some leave more of it to the contract. If you are building outside Victoria, check the schedule in your own contract against your state's building authority rather than assuming the same percentages apply. The order of the stages is broadly the same everywhere. The maximums are not.
How Interest Is Charged During the Build
Interest is charged only on the funds drawn down so far, not on the amount you were approved for. If your approved loan is $450,000 but only $90,000 has been released, interest is calculated on $90,000. At 6.5 per cent that is about $488 a month rather than the $2,438 you would be paying on the full balance.
Most borrowers take interest only repayments during the build, which keeps the cost down while the house is not yet livable. These cover the interest on drawn funds and repay no principal. Here is what that adds up to across a build.
Worked example: a $450,000 build over ten months
Using the stage percentages above, with roughly two months between drawdowns and an assumed rate of 6.5 per cent p.a., total interest across the build comes to about $10,000.
Had the full $450,000 been drawn at the start and carried for the same ten months, the interest would be about $24,400.
The staged structure saves roughly $14,400 on this build. That is the real benefit of construction finance, and it is why a slower build costs you more even when the contract price has not moved.
You are paying rent or a mortgage at the same time
This is the budgeting mistake that hurts most. During the build you are covering interest on the construction loan and your current rent or existing mortgage. On the example above that is a few hundred dollars a month early on, rising to well over a thousand by the fixing stage. Model the peak, not the average, before you commit.
How Much You Can Borrow and What Lenders Require
Construction lending is assessed against the on completion valuation, which is what a valuer says the finished property will be worth, land and building together. Your loan to value ratio is measured against that figure, not against the land alone and not against the contract price.
| LVR on completion | Loan on a $650,000 finished value | Your contribution | LMI |
|---|---|---|---|
| 80% | $520,000 | $130,000 | None |
| 90% | $585,000 | $65,000 | Payable |
| 95% | $617,500 | $32,500 | Payable, and fewer lenders |
Lenders mortgage insurance kicks in above 80 per cent, not above 90. It protects the lender rather than you, and it is a real cost that should go into your budget from the start. Many lenders will consider construction to 90 per cent, some to 95 per cent for owner occupiers, and policy tightens as the LVR climbs. Your existing land equity counts toward your contribution, which is why people who bought the block a few years ago often need far less cash than they expect.
The paperwork
What a lender will ask for
A fixed price building contract with a registered, insured builder. Cost plus contracts are much harder to finance.
Council approved plans and specifications, including the site plan and elevations.
Domestic building insurance in the builder's name, and their licence or registration details.
The progress payment schedule from the contract, so the lender can line its drawdowns up with your builder's claims.
Income, employment and credit evidence, assessed the same way as any home loan.
A list of out of contract items, covered below, because lenders increasingly want to see it.
Requirements differ meaningfully between lenders, particularly on out of contract items, owner builder work and maximum build times. That is where working with a broker saves time, because the paperwork that one lender waves through will stall at another. Everest Home Loans has more than 40 lenders on panel and works with first home buyers, investors and families across Melbourne, Sydney, Perth, Brisbane and Adelaide, in English, Nepali and Hindi.
First Home Buyer Support When You Build
Building is often the better route for first home buyers, because most of the government support is aimed at new homes.
| Support | What it does | Worth knowing |
|---|---|---|
| First Home Guarantee | Buy with a 5% deposit and no LMI, with the government guaranteeing up to 15% | No income caps and no place limits since 1 October 2025 |
| First Home Owner Grant | A cash grant, amount set by each state or territory | New homes only in every state, so building qualifies where buying established does not |
| Stamp duty concessions | Reduced or waived transfer duty for eligible first home buyers | On a house and land build, duty is often charged on the land value alone |
The First Home Guarantee covers land bought with a separate contract to build, and house and land packages. Price caps apply and they are measured on the completed value.
| State or territory | Capital city and major regional centres | Rest of state |
|---|---|---|
| New South Wales | $1,500,000 | $800,000 |
| Victoria | $950,000 | $650,000 |
| Queensland | $1,000,000 | $700,000 |
| Western Australia | $850,000 | $600,000 |
| South Australia | $900,000 | $500,000 |
| Tasmania | $700,000 | $550,000 |
| Australian Capital Territory | $1,000,000 | Not applicable |
| Northern Territory | $750,000 | $600,000 |
Grant amounts and duty concessions vary a great deal by state and change from year to year, so check the current figure with your state revenue office before you build a budget around it.
What Happens When Construction Is Complete
Once the final stage is signed off and the occupancy permit issued, the loan converts to a standard home loan with principal and interest repayments. Some lenders roll it over automatically. Others want a fresh application or a formal refinance.
That conversion point is worth treating as a decision rather than an administrative step. Your loan was priced at the rate available when you applied, possibly a year or two earlier, and you now have a completed property and a repayment history behind you. Comparing offers before you convert, rather than after, is the difference between a rate you chose and a rate you inherited. Our comparison of going direct to a bank versus using a broker covers how that process works.
Do not assume your construction lender's rate is still competitive once the build is finished. A few weeks of comparison before converting can be worth thousands across the remaining term.
Where Builds Go Wrong
Most construction finance problems are not finance problems. They are build problems that land on the finance.
- Out of contract items. Driveway, landscaping, fencing, floor coverings, blinds, letterbox. These are frequently excluded from the building contract and from the loan. They can run to tens of thousands and they are due at the end, when your cash is thinnest. Price them before you sign, not after lock-up.
- Variations. Every change you make mid-build is a variation, and the lender will not usually fund it without reassessing. Variations are also where the contract price quietly climbs.
- Delays. Weather, supply, trades, council. Every extra month is another month of interest, and some lenders impose a maximum build period, typically around twelve to eighteen months, after which they can stop drawing.
- Builder insolvency. Domestic building insurance exists for this, with cover limits and conditions that vary by state. Check the builder is registered and that the policy is in place before the first payment leaves.
- A valuation that comes in short. If the on completion valuation lands below the contract price plus land, your LVR rises and you cover the gap in cash. This is the most common reason a construction approval falls over late.
- No contingency. Build a buffer of 10 to 15 per cent of the contract price into your own funds. Lenders will not generally release money beyond the approved amount without reassessing your application.
The Takeaway
Construction loans release money in stages and charge interest only on what has been drawn, which on a typical build saves many thousands against a fully drawn loan. The parts that catch people out sit either side of that: the LMI threshold at 80 per cent of the completed value, the out of contract items that are not in the loan at all, and the conversion point at the end where most people simply accept whatever rate they are given.
Get the contract, the valuation and the contingency right at the start and the finance side usually takes care of itself.
Planning a build? Let us map the finance before you sign the contract
Everest Home Loans works with first home buyers, investors and families building across Melbourne, Sydney, Perth, Brisbane and Adelaide.
Book a free consultation Call 0431 790 889- Compare construction policy across more than 40 lenders, including maximum build periods
- Work out your real cash requirement once LMI and out of contract items are counted
- Check your eligibility for the First Home Guarantee, grants and duty concessions
- Line the drawdown schedule up with your builder's payment claims
- Review your options again at conversion rather than rolling over by default
- Talk it through in English, Nepali or Hindi
Email: raj@everesthomeloans.com.au
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Frequently Asked Questions
How long does a construction loan usually last?
Most run one to three years, covering the period from the first drawdown to final completion. Many lenders also set a maximum build period, often around twelve to eighteen months, after which they can decline to release further funds without a reassessment.
Weather, supply shortages and builder scheduling all stretch the timeline, and every extra month is another month of interest. Build a buffer into both your budget and your expectations.
Can first home buyers get a construction loan with a government grant?
Yes. Building usually puts you in a better position than buying established, because the First Home Owner Grant applies to new homes only in every state, and stamp duty on a house and land build is often charged on the land value alone.
The First Home Guarantee covers land bought with a separate contract to build, as well as house and land packages. Since 1 October 2025 it has no income caps and no limit on places, with a 5 per cent deposit and no LMI. Price caps apply, measured on the completed value.
What if construction costs more than expected?
Lenders will not generally release funds beyond the approved amount without reassessing your application, which takes time you may not have mid-build. If costs rise you will usually need extra savings or an approved loan increase.
Build a contingency of 10 to 15 per cent of the contract price into your own funds before construction starts, and price your out of contract items at the same time.
Do I need a licensed builder to get a construction loan approved?
Effectively yes. Most lenders require a fixed price contract with a registered, insured builder, along with domestic building insurance in the builder's name. The requirement protects you as much as the lender, because that insurance is what responds if the builder fails mid-build.
Owner builder finance exists but is far more restricted, usually at a much lower LVR and with a smaller pool of lenders.
What is an out of contract item and why does it matter?
Anything the building contract excludes: driveway, landscaping, fencing, floor coverings, blinds, clothesline, letterbox. They are not part of the contract price, so they are usually not part of the loan either.
They can total tens of thousands and they fall due at the end of the build, when your savings are at their lowest. Some lenders will hold back part of the final drawdown until they are complete, because a home without a driveway or floor coverings does not value at the figure the approval assumed.
What happens if the on completion valuation comes in low?
Your LVR rises, because the loan is measured against the valuation rather than what you agreed to pay. That can push you over an LMI threshold, increase the premium, or reduce the amount the lender will advance, leaving a gap you cover in cash.
It is the most common reason a construction approval falls over late in the process. Getting a realistic view of the completed value before signing the building contract is the way to avoid it.
Do I make repayments during construction?
Yes, but only interest on the funds drawn so far. The repayment starts small and climbs with each progress payment, stepping up sharply at lock-up, which is the largest single drawdown.
Remember you are also paying rent or an existing mortgage through the same period. Budget against the peak repayment near the end of the build rather than the average across it.
Sources
- Consumer Affairs Victoria, Deposits and payments for building work. Maximum deposit and progress payment percentages under the Domestic Building Contracts Act 1995 (Vic).
- Housing Australia, First Home Guarantee. Eligible property types, including land with a separate contract to build and house and land packages.
- Mozo, Home Guarantee Scheme guide. Scheme settings from 1 October 2025 and property price caps by state and territory.
- ASIC MoneySmart, Lenders mortgage insurance. LMI applies above 80 per cent LVR and protects the lender, not the borrower.
This article is general information only and does not take your objectives, financial situation or needs into account. Lender policies, government scheme settings, grant amounts and duty concessions change, and the figures quoted were current at the date of publication. Worked examples are illustrations based on the stated assumptions and assume no variations, no delays and no change in rate. Progress payment maximums cited are those applying in Victoria. Consider whether the information is appropriate for you and seek your own advice before acting. Kandel & Co Pty Ltd trading as Everest Home Loans, ACR 506833. Rajesh Kandel, Authorised Credit Representative 476341 of Connective Credit Services Pty Ltd, ABN 77 161 731 111, Australian Credit Licence 389328.
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Kandel & Co Pty Ltd t/a Everest Home Loans is an Authorised Credit Representative – 506833, and Rajesh Kandel is an Authorised Credit Representative number – 476341 of Connective Credit Services Pty Ltd ABN 77 161 731 111 (Australian Credit Licence No.389328).
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