Construction finance operates differently from standard home loans because you're funding a project that doesn't exist yet, and that difference shows up in how drawdowns work, how interest accrues, and what lenders require before approving each stage.
Progressive Drawdown: You Only Pay Interest on Funds Released
Lenders release construction funds in stages as your build progresses, not as a lump sum at settlement. You only pay interest on the amount drawn down at each stage, which means your repayments start lower and increase as more funds are released. During construction, most borrowers make interest-only repayments on whatever portion of the loan has been drawn, then switch to principal and interest once the build is complete and the loan converts to a standard home loan.
Consider a company director building a custom home in the Inner West. The total loan amount is approved upfront, but funds are released across five or six stages, starting with a deposit to the builder and land purchase, then progressing through base, frame, lockup, fixing, and completion. For the first few months, interest might apply only to the land component and initial deposit, keeping repayments manageable while the project ramps up.
How the Progress Payment Schedule Aligns with Your Building Contract
The progress payment schedule in your building contract must align with the construction draw schedule set by your lender. Most lenders work with a standard five or six-stage drawdown, tied to milestones like base stage, frame stage, and lockup. If your builder has structured the contract with different payment triggers or more frequent draws, the lender may require adjustments before approval.
In our experience, self-employed borrowers with fixed price building contracts encounter fewer complications during drawdown because each stage is clearly defined and the total cost is locked in. Cost plus contracts, where the builder charges actual costs plus a margin, require more documentation at each stage and can trigger additional scrutiny from lenders if costs start to drift above the approved loan amount.
Progressive Drawing Fees and Inspection Costs
Most lenders charge a progressive drawing fee each time funds are released, typically between $150 and $400 per draw depending on the lender. Over a five-stage build, that can add up to $1,500 or more in fees that aren't part of the loan amount. Some lenders will capitalise these fees into the loan, others require payment upfront before releasing each stage.
Lenders also arrange a progress inspection before approving each drawdown to verify the work has been completed to the standard claimed. The inspection is usually conducted by a quantity surveyor or building inspector, and the cost is either absorbed by the lender or passed on to you as part of the progressive drawing fee. If the inspector identifies incomplete work or variations from the approved plans, the lender may hold back part of the drawdown until the issue is resolved.
Fixed Price Contracts and Why Lenders Prefer Them
A fixed price building contract gives the lender certainty that the project cost won't exceed the approved loan amount. Lenders prefer working with registered builders who carry appropriate insurance and have a track record of completing projects on schedule. If you're engaging an owner builder arrangement, expect higher deposit requirements and more restrictive loan terms, as lenders view owner builder finance as higher risk.
The contract should specify that you must commence building within a set period from the disclosure date, usually six to twelve months. If construction doesn't start within that window, the lender may require a new valuation or reassess your financial position before releasing funds.
Interest Rate Structures During Construction
Construction loan interest rates are typically variable during the building phase, even if you plan to fix the rate once the loan converts to a standard home loan after completion. Some lenders offer the option to lock in a fixed rate for the construction period, but the choice is more limited and rates are often slightly higher than their standard variable construction rate.
For self-employed borrowers, the rate you're offered depends on the strength of your financials and the loan-to-value ratio. A company director with two years of strong financials and a 20% deposit will access better pricing than someone borrowing at 90% with variable income patterns. Once construction is complete and the loan converts, you can usually choose between variable, fixed, or split rate options without reapplying, though some lenders require a formal variation.
Land and Construction Packages Versus Buying Land First
If you're purchasing land and building in a single transaction, the lender treats it as a land and construction package, releasing funds for the land purchase first, then progressively for the build. If you already own the land, either outright or with an existing mortgage, the construction loan is structured to refinance the land or sit alongside it, with drawdowns covering only the building costs.
In areas like the Northern Beaches or Hills District, where suitable land for custom builds is still available but increasingly scarce, buying land first and building later can give you more control over design and timing. However, holding land without income while arranging construction finance means demonstrating to the lender that you can service both the land loan and the future construction loan simultaneously, which requires strong cashflow evidence for self-employed applicants.
Council Approval and Development Application Requirements
Lenders require evidence of council approval before releasing construction funds. That means your development application must be approved and all conditions satisfied, with a construction certificate issued, before the first drawdown. If your DA is still under assessment or subject to conditions you haven't yet met, the lender will issue conditional approval for the loan but won't release funds until you provide the necessary documentation.
For renovations or extensions, lenders apply similar scrutiny. A house renovation loan tied to significant structural work will require the same level of council documentation as a new build, along with a clear scope of works and fixed price contract with a licensed builder. If you're coordinating multiple trades directly rather than using a head contractor, lenders will usually require you to go through the owner builder approval process, which comes with higher deposit requirements and more limited construction loan options.
Additional Payments and Flexibility During the Build
Most construction loans allow additional payments during the interest-only phase, which can reduce the balance before the loan converts and lower your ongoing repayments once principal and interest kicks in. However, not all lenders offer full redraw or offset account functionality during construction, so if you're likely to need access to surplus funds, confirm the loan structure before committing.
Some lenders also allow you to make lump sum payments toward future drawdowns, effectively reducing the amount you'll need to borrow at later stages. For self-employed borrowers with variable income, this can provide a buffer if cashflow is stronger in some months than others, though you'll need to confirm with your lender that the funds are allocated correctly and not treated as an overpayment that gets returned.
When the Loan Converts to a Standard Home Loan
Once construction is complete and you've received an occupation certificate, the loan converts from construction mode to a standard home loan. At that point, repayments switch from interest-only on the drawn portion to principal and interest on the full loan amount, and you'll have access to the full range of loan features the lender offers, including offset accounts, redraw, and the option to fix part or all of the balance.
The conversion usually happens automatically once the lender receives the occupation certificate and conducts a final valuation. If the completed property value comes in higher than the initial land and construction valuation, you may have access to additional equity, which can be useful if you're planning further improvements or want to refinance into a more competitive product.
Call one of our team or book an appointment at a time that works for you. We'll walk through your financials, review your building contract, and structure the construction loan to align with your build timeline and cashflow.
Frequently Asked Questions
How does progressive drawdown work on a construction loan?
Lenders release funds in stages as your build progresses, typically across five or six milestones like base, frame, and lockup. You only pay interest on the amount drawn down at each stage, which keeps repayments lower during construction.
What fees apply to each drawdown during construction?
Most lenders charge a progressive drawing fee of $150 to $400 each time funds are released, plus the cost of a progress inspection to verify the work. Over a typical five-stage build, total fees can reach $1,500 or more.
Do I need council approval before construction funds are released?
Yes, lenders require an approved development application and construction certificate before releasing the first drawdown. If your DA is still under assessment, the loan will remain conditionally approved until all documentation is provided.
Can I make additional payments during the construction phase?
Most construction loans allow additional payments during the interest-only phase, which reduces the balance before the loan converts. However, not all lenders offer full redraw or offset functionality during construction, so confirm the terms upfront.
What happens when construction is complete?
Once you receive an occupation certificate, the loan converts to a standard home loan and repayments switch to principal and interest. You'll then have access to features like offset accounts and the option to fix part or all of the rate.
