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How Does A Construction Loan Work With Knock Down Rebuilds?

signing construction loan documents

How does a construction loan work with knock down rebuilds?

Note: Specific requirements and processes may vary among lenders. We recommend consulting a mortgage broker or financial advisor to understand the details and obtain accurate information based on your individual circumstances.

A knock down rebuild project is an exciting and convenient way to build — it allows you to breathe new life into your existing property, creating the home you've always wanted without sacrificing the location you love. However, financing a knock down rebuild project requires careful consideration and a solid understanding of construction loans.

So, how do construction loans work?

Whether you're ready for a transformational journey or just curious about the possibilities for your current home, we’re here to demystify knock down rebuild loans and provide the essential information you need to make a smart decision about financing the project.

How does a construction loan work?

A construction loan is specifically designed for financing the construction or renovation of a property. It provides funds to cover the costs of building or renovating a home, like land acquisition, construction materials, labour, and other expenses. Here's how a construction loan generally works.

How a construction loan works
  • Application process: To get a construction loan, you’ll need to talk to a lender, like a bank or a mortgage broker. They can assess your likelihood of being approved for a loan before you apply. The lender will assess your financial situation, including your income, credit history, and the value of the project. Then, it’s time to apply!

    Note: this is also the time to get a quote from your builder. Once you have received this (and as long as you have been given verbal consent from your lender), you can proceed with your builder — but at this stage, do not sign any contracts. This comes later once you have pre-approval from your bank.
  • Loan approval: If your application is approved, the lender will provide a loan offer outlining the terms and conditions, including the loan amount, interest rate, repayment period, and associated fees.
  • Valuation and documentation: Before the loan is finalised, the lender might need a property valuation to determine its current and projected value after construction. You'll need to provide relevant documentation, like building plans, contracts with builders, and permits.
  • Loan drawdown: Unlike a traditional home loan, where the entire amount is received upfront, construction loans are drawn down in stages (also known as progress payments). These payments are made at specific milestones throughout the construction process (usually 5 payments), like completion of the foundation, framing, roofing, etc.
  • Interest payments: During the construction phase, you'll usually make interest-only repayments on the funds drawn down. This helps keep your monthly payments lower during the construction period. The interest rate can be variable or fixed, depending on the loan terms you've agreed upon with the lender.
  • Inspections and certifications: Before each progress payment, the lender will often require inspections to ensure the work has been completed according to the agreed-upon plans and specifications. The homeowner or lender inspector may carry out these inspections. Once the inspections are satisfied, the lender releases the funds for the next stage.
  • Conversion to a mortgage: Once construction is complete, the loan converts into a regular mortgage, and you'll start making principal and interest repayments. The loan will be based on the total amount drawn down during construction, and the repayment term will be determined as per the loan agreement.

It's important to note that the specifics of construction loans vary among lenders, so we recommend shopping around, comparing loan offers, and reviewing the terms and conditions before committing to a loan. 

Meeting with a mortgage broker or financial planner helps understand the ins and outs of construction loans.

Can I knock down and rebuild with an existing mortgage?

Yes, it’s possible to undertake a knock-down rebuild project with an existing mortgage! To start, you’ll need to review the terms and conditions of your existing mortgage and find out if there are any restrictions or penalties associated with making changes to the property, like demolishing the house.

We recommend contacting your lender to discuss your plan to knock down and rebuild — they can provide information on how your existing mortgage will be affected and what options are available. They might also recommend refinancing or modifying your mortgage to accommodate the new construction project.

Other common questions about knock down rebuild loans

We understand that every knock down rebuild project is unique, with its own set of challenges and opportunities. That's why we've compiled a list of frequently asked questions to address common concerns and provide guidance tailored to your specific needs. Whether you're wondering about living arrangements during construction or leveraging existing equity, we're here to provide the answers.

  • Do you pay the mortgage while the house is being built?
    During the construction phase of a house, you typically make interest-only payments on the funds drawn down from the construction loan. These payments are made to cover the interest charges on the money you have used for construction up to that point.
  • When do you start paying the mortgage on a new build?
    Your knock down rebuild loan will convert to a regular mortgage once construction is complete. 
  • How does the lender determine the value of a knock down rebuild?
    The property's value depends on various factors, like the location, land size, existing structure condition (if any), and the estimated value of the new home after construction.
  • What happens if the construction costs exceed the loan amount?
    If the construction costs exceed the estimated budget, you’ll need to consider additional funding options. This could involve using personal savings, getting additional financing, or reassessing the project scope and specifications. Communicating with your builder and lender is important to discuss potential solutions.
  • Can I live on the property during the construction phase?
    Living on the property during construction depends on the circumstances and extent of the work that needs to be done. For example, if you have a granny flat on-site, you may be able to continue living on the block during the build. However, we recommend looking for alternative accommodation for your ultimate comfort and convenience!
  • Can I use the equity in my existing property towards the knock-down rebuild?
    Yes, if you have equity in your existing property, it can be used as collateral or as a funding source for the knock-down rebuild project. You can borrow against the equity in your property or use it to secure a construction loan.

Start a knock down rebuild project with Montgomery Homes today!

Now that you’re armed with this essential knock down rebuild knowledge, you're ready to transform your existing property into your dream home. Remember to communicate openly with lenders and builders, seek professional advice, and stay true to your vision. Embrace the journey and enjoy the process of creating a home that reflects your unique style and needs!

Get in touch with the team at Montgomery Homes to start the knock down rebuild process today.

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