What Not to Miss When Settling a Construction Loan

Construction loan settlement happens in stages, not once.

Unlike a standard home loan where you receive the full amount at settlement, construction finance is released progressively as your build reaches specific milestones. You'll typically settle on the land first, then access additional funds through a series of drawdowns as the foundation is poured, the frame goes up, and each stage is completed. The lender sends a valuer or building inspector to verify progress before releasing each payment, and you only pay interest on the amount drawn down so far.

How the Land Component Settles First

The first settlement happens when you purchase the land. If you're buying a house and land package or securing suitable land separately, this initial settlement works much like any property purchase. The lender releases funds to complete the land purchase, and you take ownership of the site. Interest begins accruing on this portion immediately, even though construction hasn't started. Most lenders structure this as interest-only repayment during the construction phase, which keeps your payments lower while the house is being built.

Consider a couple purchasing land in Mentone for a custom home. They settle on the block in February, paying interest only on that land component while waiting for council approval and the registered builder to commence work. By April, the development application is approved and construction begins. At this point, they're still only paying interest on the land value, with the construction funds yet to be drawn.

The Progressive Drawing Fee and How It Works

Most lenders charge a fee each time they release funds during construction. This Progressive Drawing Fee typically ranges from around $200 to $400 per drawdown, and with five to seven drawdowns across a typical build, these costs add up. Some lenders cap the total fees, while others charge per inspection. The fee covers the cost of the valuer or building inspector who visits the site to confirm that the stage has been completed to the required standard before the lender releases payment to your builder.

In our experience, buyers building in areas like Brighton East or Beaumaris often underestimate these fees when budgeting for their build. If your construction loan involves six progress payments and the lender charges $350 per drawdown, that's an additional $2,100 to factor into your overall costs. Some lenders waive or reduce these fees as part of a construction finance package, so it's worth comparing options early.

What the Progress Payment Schedule Actually Controls

The progress payment schedule in your building contract dictates when your builder gets paid, but the lender controls when funds are actually released. These two schedules need to align, or you'll face delays. Most fixed price building contracts break payments into stages such as base stage, frame stage, lock-up stage, fixing stage, and completion. Your lender will have their own version of these milestones, and they don't always match perfectly.

A common issue arises when the builder's contract specifies payment upon completion of a stage, but the lender requires a progress inspection that takes several days to arrange. If your builder expects payment on a Friday and the valuer can't inspect until the following Tuesday, that delay can create tension. Sharing the construction draw schedule with your builder before work starts helps avoid this.

Council Plans and Approval Timing

You can't draw construction funds until council approval is finalised. Even if you've settled on the land and signed a fixed price contract with your registered builder, the lender won't release construction funds until they sight the approved building permit. Depending on the council and the complexity of your custom design, this approval process can take weeks or even months. Some lenders require you to commence building within a set period from the disclosure date, which adds pressure if council delays push your start date back.

If you're building in areas like Cheltenham or Bentleigh, where council plans can involve additional heritage or vegetation overlays, factor in extra time for the approval process. Missing the lender's construction commencement deadline can mean reapplying for your construction loan, potentially at a different interest rate.

How Interest Accrues During the Build

You only pay interest on the amount drawn down at any given time, not the full loan amount. This is one of the key differences between construction finance and a standard home loan. If you've drawn down for land and the base stage, you're paying interest on that portion while the rest of the approved loan amount sits untouched. As each stage completes and more funds are released, your interest payments increase incrementally.

At current variable rates, this structure can work in your favour during the construction phase. Instead of paying interest on the full loan amount from day one, your repayments build gradually over the course of the build. Once construction is complete and all funds have been drawn, the loan typically converts to a standard principal and interest or interest-only home loan, depending on what you've arranged with your lender.

Fixed Price Contracts vs Cost Plus Arrangements

Most lenders prefer fixed price contracts for construction loans because they provide certainty around the final loan amount. A fixed price building contract locks in the total cost, which means the lender knows exactly how much will be drawn down across the build. A cost plus contract, where you pay the builder's costs plus a margin, creates uncertainty and makes it harder for lenders to assess risk. Some lenders won't offer construction funding at all for cost plus arrangements, while others will require a larger buffer or higher interest rate.

If you're planning a custom build in Hampton or Black Rock, most registered builders will offer a fixed price contract as standard. This not only makes construction loan approval more straightforward but also protects you from unexpected cost blowouts during the build.

When Owner Builder Finance Changes the Process

Owner builder finance is harder to secure and comes with stricter conditions. If you're acting as your own builder, most lenders will require evidence of your qualifications, experience, and a detailed breakdown of how you'll manage the build. You'll need to demonstrate that you can pay sub-contractors such as plumbers and electricians on time, and that you understand the construction process well enough to deliver a quality build. The progress inspection process is also more rigorous, as the lender has no registered builder to rely on for project management.

Drawdowns for owner builders are often structured differently, with funds released directly to you rather than to a building company. This gives you control but also places responsibility on you to manage payments and keep the project on schedule. Many lenders in our experience will only offer owner builder finance to clients with a proven track record in construction or building trades.

What Happens at Final Drawdown and Conversion

The final drawdown occurs once the build is complete and the final inspection has been passed. At this stage, the lender releases the remaining funds, and your construction loan converts to a standard home loan. This conversion is sometimes called construction to permanent loan, and it should happen automatically if it's been structured correctly from the start. You'll move from interest-only repayment options to principal and interest repayments unless you've arranged otherwise.

Once converted, your loan operates like any other home loan, and you can explore options such as refinancing if your circumstances change or if you want to access a lower interest rate down the track. If you've built an investment property, you may choose to keep the loan on an interest-only structure, which you can discuss with your mortgage broker before the conversion happens.

Construction loan settlement is a process, not an event. Understanding how funds are released, what fees apply, and how your repayments build over time keeps your project on track and your budget intact. Call one of our team or book an appointment at a time that works for you.

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