When is a Construction loan NOT a Construction Loan?

2004 0822 Image0034 ​Simplifying your construction loan

Construction lending can be confusing at the best of times, and it can be even more confusing when you explain to your bank that you want to build a home, then apply for a loan expecting it to be a progress payment construction loan.

A Turn-Key Loan

Many clients end up with a “turn-key” loan offer, not fully aware of what that means for them.

Turn-key is defined as the builder and land developer delivering a fully completed home, where a Code Compliance Certificate is issued, and the home is ready for occupation.

A Turn-key loan is NOT a construction loan! 

So what does this actually mean?  It means in most instances that the land and build design have been pre-selected and priced (including a margin to cover the builder's finance costs), and that you are buying a home that has not yet been built.  You are normally required to pay a 10% deposit to the builder who then arranges to purchase land directly from the developer (or worse – building your home on land still owned by the developer).

If your contract is to settle and take possession only once the home has Code Compliance Certificate (CCC) normally there is very little flexibility in design, colours or other features that personalize your home.  The house is sold  based on a fixed sale price. While convenient, these pre-packaged builds often have very little flexibility.

There is a perception this is more convenient, and in some instances it may be.  But your builder must now pay the cost of both owning the land and paying the commercial interest rates until the home is completed and you settle.  These costs will be built into the purchase price so while many believe this is cheaper than paying for a progress payment loan, in most instances it isn’t.

Turn-key is popular because clients don’t need to pay their rent and a construction loan at the same time, and because banks are more likely to permit a low deposit purchase if they don’t have to manage the build loan.  This may seem like a good option.

Advantages:
1. For some, it's convenient to pay a deposit, let the builder get on and build the home and upon completion they purchase that home
2. Banks like to offer turn-key as they simply don't have to manage the build, and they just fund once the home is completed, so securing a turn-key loan is easier

Disadvantages:
1. The clients normally must pay at least 10% deposit
2. The finance costs are hidden in the contract and can be higher than a progress payment loan
3. Your deposit is entirely at risk if your builder or land developer go under; you have no rights to the home and you lose your deposit
4. You usually have little control over the design, specifications or changes to the build, and in some instances the builder may refuse to let you on site to inspect until the home is completed
5. Most builders simply don't have the resources to fund a turn key loan

Progress Payment Loan (also known as a Construction Loan)

A progress payment loan requires the purchaser to settle the land at the very beginning of the build, and to settle a construction loan that will make payments progressively to the builder until the home is completed.  There are definite advantages and disadvantages to a standard construction loan

Advantages:

1. Your builder or developer do not have to fund the project, so the funding costs are not hidden in the contract price
2. You have ownership of your land and your build from the start, so should the worst happen and your builder can't complete your build, you own everything (opposite to a turn key)

Disadvantages:

1. If you require a loan for the land and build, you will be required to make interest repayments throughout the build.  That can become financially stressful if you have to pay rent or mortgage and construction loan interest at the same time (not with NewBuild, so read on)

The Best Option - NewBuild "Client Turn-Key"

1. You may be approved with as little as 5% deposit for house and land

2. Your deposit is paid up front, but you are not required to make any construction loan repayments until the home is completed (or 12 months – whichever comes first)

3. You will incur interest at residential rates, and you will not pay one cent more than the actual costs, which could save you thousands of dollars

4. When you pay your deposit you will settle on the land and build, so no matter what happens you own everything that you have paid for