Understanding the Basics of Construction Investment Loans

Building an investment property from the ground up requires a different type of finance to a standard mortgage.

A construction loan releases funds in stages as your build progresses, which means you only pay interest on what's been drawn down rather than the full loan amount from day one. For investors in Ashburton looking to capitalise on the suburb's established appeal while adding rental stock, understanding how progressive drawdowns and fixed price building contracts work will determine whether your project remains viable.

How Construction Loans Differ from Standard Investment Loans

With a construction loan, the lender releases funds progressively as each stage of the build is completed, not as a lump sum at settlement. You'll typically make interest-only payments during construction, calculated only on the amount drawn down at each stage. Once construction is complete, the loan converts to a standard investment loan with principal and interest repayments, though interest-only repayment options may continue depending on your lender and borrowing position.

Consider an investor building a dual-occupancy project on a subdivided block near the Ashburton shops. The land purchase might be $850,000, with construction costs of $600,000. Rather than paying interest on $1.45 million from day one, the investor pays interest only on the land loan initially, then progressively on each construction drawdown as the slab, frame, lock-up, and final stages are completed. Over a typical six-month build, this staged approach can reduce interest costs by $15,000 to $25,000 compared to borrowing the full amount upfront.

Most lenders will require a registered builder, council approval, and a fixed price building contract before approving construction finance. Owner builder finance exists but typically requires significant equity and building experience.

Fixed Price Contracts and Cost-Plus Arrangements

Lenders strongly prefer fixed price building contracts because they limit cost blowouts and provide certainty around the final loan amount. Under a fixed price contract, the builder agrees to complete the project for a set sum regardless of material cost increases or unforeseen site issues, with the exception of variations you request.

A cost plus contract, where you pay the builder's actual costs plus a margin, offers more flexibility in design changes but introduces uncertainty around the final amount owing. Most mainstream lenders won't approve construction loans against cost plus contracts for investment properties. If you're pursuing a custom design that requires significant flexibility, expect to provide a larger deposit or consider specialist lenders who assess these arrangements on a case-by-case basis.

The Progressive Drawing Fee and Progress Payment Schedule

Each time the lender releases funds, they'll arrange a progress inspection to confirm the stage is complete. This usually involves a quantity surveyor or building inspector attending the site. Lenders charge a Progressive Drawing Fee for each inspection and drawdown, typically $300 to $500 per stage.

The progress payment schedule in your building contract should align with the lender's drawdown structure. Standard stages include base stage (slab or footings), frame stage, lock-up stage (roof and windows installed), fixing stage (plumbing, electrical, plastering), and practical completion. The builder invoices at each stage, you request a drawdown from the lender, the lender inspects, and funds are released directly to the builder.

Misalignment between your building contract and the lender's drawdown policy creates funding gaps. If your builder requires five progress payments but your lender only approves four drawdown stages, you'll need to cover the difference from your own funds. Clarify the lender's drawdown structure before signing your building contract.

Land and Construction Packages vs Established Land

You can finance construction on land you already own or purchase land and construction together as a single package. Construction loans can structure either arrangement, though the timing differs.

If you're buying a house and land package from a developer, the developer typically holds the land until construction begins or reaches a certain stage. You settle on both land and construction concurrently, which means you avoid holding costs on vacant land. If you're purchasing suitable land separately, you'll settle on the land first, then commence building within a set period from the settlement date. Many lenders require construction to start within 12 months of land settlement, and some limit how long you can hold the land before drawdowns begin.

For Ashburton investors, buying an older home on a larger block, demolishing, and rebuilding is common given the suburb's mature housing stock and 800-square-metre-plus allotments near Warrigal Road. This approach requires two separate loan stages: first, purchasing the existing property, then refinancing into a construction loan once you have council plans and a building contract. Some lenders will approve the construction loan before you purchase the existing home, conditional on demolition occurring within a set timeframe.

Interest Rates and Serviceability for Investment Construction Loans

Construction loan interest rates for investment properties typically sit 0.20% to 0.50% higher than standard variable investment loan rates during the construction phase. Once the build is complete and the loan converts to a standard investment loan, the rate adjusts to the lender's prevailing investment loan pricing.

Serviceability is assessed on the completed investment property, not just the land or construction costs in isolation. The lender will require a qualified valuer to provide an 'as if complete' valuation, estimating the property's market value once construction finishes. This valuation determines your loan-to-value ratio and borrowing capacity. If the valuation comes in lower than expected, you may need to increase your deposit or reduce the loan amount.

Rental income is included in serviceability, though lenders typically apply a shading factor of 75% to 80% to account for vacancy periods and maintenance costs. Because the property won't generate income until construction is complete, you'll need to demonstrate you can service both the construction loan interest during the build and the full loan repayments once tenanted, often while still covering your own living expenses or existing mortgage.

Council Approval and Development Applications

You cannot access construction funding until you have formal council approval. A development application is required for most new builds, significant renovations, or projects that deviate from standard planning overlays. In Ashburton, where neighbourhood character overlays apply in parts of the suburb, expect council to scrutinise building height, setbacks, and materials.

Approval timeframes vary, but eight to twelve weeks is typical for straightforward projects. If your application requires third-party notice or triggers objections from neighbours, the process can extend to six months or more. Factor this timeframe into your feasibility analysis, particularly if you're holding costs on land or a property awaiting demolition.

Once council approval is granted, you'll typically have two years to commence building, though this varies by council and project type. Lenders require a copy of your building permit and stamped council plans before issuing formal loan approval.

When Construction Converts to Permanent Loan

Practical completion occurs when the builder has finished all works under the contract and the property is ready for occupation, even if minor defects remain. At this point, you'll receive a Certificate of Occupancy or Certificate of Final Inspection from the building surveyor, and the lender will conduct a final inspection.

The loan then converts from construction to a standard investment loan. Interest is now charged on the full loan amount, and repayments switch from interest-only construction payments to the agreed repayment structure for your investment loan, whether interest-only or principal and interest. This is also when you can refinance to a different lender if you secured the construction loan with a second-tier lender and now want access to lower rates from a major bank.

Tenanting the property and starting to receive rental income should occur as close to practical completion as possible to minimise the gap where you're servicing the full loan without rental offset.

Call one of our team or book an appointment at a time that works for you to discuss how a construction loan structures for your specific project and what deposit you'll need to proceed.

Frequently Asked Questions