Smart ways to approach construction loans for investment

Building an investment property through construction finance means you only pay interest on what's been drawn down, not the full loan amount from day one.

A construction loan works differently to a standard home loan because the funds are released in stages as the build progresses. You're charged interest only on the amount drawn down at each stage, which keeps your holding costs lower during the build. Once construction is complete, the loan typically converts to a standard investment loan with principal and interest or interest-only repayment options depending on your strategy.

For investors in Oakleigh looking to build on vacant land or develop an existing site, understanding how progressive drawdowns and progress payment schedules work will help you plan cash flow and avoid delays that can push out settlement and increase costs.

What lenders look for in a construction loan application for investment property

Lenders assess construction loan applications differently to purchase loans because the security doesn't exist yet. They'll want to see council approval, a fixed price building contract with a registered builder, detailed plans, and a clear progress payment schedule. Your borrowing capacity is calculated based on the end value of the completed property, not just the land value.

Most lenders will lend up to 80% of the completed property value for investment builds, though some may go higher with lender's mortgage insurance. The land must be suitable for construction, and you'll usually need to commence building within a set period from the disclosure date, often six to twelve months depending on the lender.

Consider an investor who owns a 600-square-metre block in Oakleigh and wants to subdivide and build two townhouses at the rear. The council plans are approved, the registered builder has provided a fixed price contract, and the total project cost including land is within the investor's borrowing capacity. The lender assesses the end value of both completed townhouses, confirms the progress payment finance structure aligns with their drawdown process, and approves the construction funding on an interest-only basis during the build.

How the progressive drawdown process works during construction

Funds are released in instalments based on the progress payment schedule agreed between you, the builder, and the lender. Typically there are five to six drawdowns: deposit, base stage, frame stage, lockup stage, fixing stage, and completion. Before each drawdown, the lender arranges a progress inspection to confirm the work has been completed to the required standard.

You'll be charged a progressive drawing fee each time funds are released, usually between $150 and $300 per drawdown depending on the lender. Interest is calculated daily on the amount drawn down, so if only half the loan has been released, you're only paying interest on that portion. This structure keeps your repayments lower during construction compared to borrowing the full amount upfront.

The builder invoices you at each stage, you submit the invoice to the lender, the inspection is completed, and the funds are transferred directly to the builder or to your account depending on the lender's process. Timing matters because delays in inspections or incomplete work can hold up drawdowns and delay the builder, which can create tension and cost overruns.

Fixed price contracts and cost plus contracts in construction finance

Most lenders prefer a fixed price building contract because it reduces risk for both you and the lender. The contract sets out the total build cost, the progress payment schedule, and the scope of work. Changes during construction require a variation, which may need lender approval if it affects the loan amount or end value.

A cost plus contract, where you pay the builder's costs plus a margin, is harder to finance because the final cost isn't fixed. Some lenders won't approve construction funding on a cost plus basis, and those that do will apply stricter conditions and may require a larger deposit or contingency buffer.

If you're acting as an owner builder, fewer lenders will support the project, and those that do will require evidence of your building experience, detailed costings, and often a higher deposit. For most investors, working with a registered builder under a fixed price contract is the most reliable path to approval and completion.

Interest-only repayment options during and after construction

During the construction phase, you'll typically make interest-only payments on the amount drawn down. Once construction is complete and the loan converts to a standard investment loan, you can choose to continue on interest-only for a set period, usually one to five years, or switch to principal and interest repayments.

Interest-only repayments keep your monthly outgoings lower, which can be useful if the property won't be generating rental income immediately or if you're holding it for capital growth. You're not reducing the loan balance, but you're maximising cash flow and deductibility if the property is negatively geared.

Some lenders offer a construction to permanent loan structure where the interest rate and repayment type are locked in from the start. Others treat construction and post-construction as separate phases, which means the rate or terms may change once the build is finished. Clarifying this upfront avoids surprises when the loan converts.

Land and construction packages versus buying land separately

A land and construction package, often offered by developers selling house and land packages, bundles the land purchase and build contract together. These can be convenient because the developer has pre-approved builders and designs, and some lenders have streamlined approval processes for certain packages.

Buying suitable land separately and arranging your own custom design and builder gives you more control but requires more coordination. You'll need to secure council approval, engage a registered builder, and manage the progress payments yourself. Both approaches work for construction finance, but the land and build loan structure is slightly different depending on whether the contracts are linked or separate.

If you're buying land in Oakleigh's established residential zones and planning a custom home or dual occupancy, expect the development application and council approval process to take several months. Factor this into your timeline because most lenders require approved plans before they'll finalise the construction loan application.

Managing cash flow and additional payments during the build

Because interest accrues only on the amount drawn down, your repayments increase as each stage is completed and more funds are released. If the first drawdown is 20% of the total loan, your interest repayment is calculated on that 20%. Once the second drawdown takes you to 40%, your repayment increases accordingly.

Some investors make additional payments into an offset or redraw facility linked to the construction loan to reduce interest charges during the build. Not all construction loans offer offset accounts, so confirm this with your lender if it's part of your cash flow strategy.

You'll also need to budget for costs outside the loan amount, such as connection fees for plumbers and electricians, council inspections, and any variations to the building contract. These aren't always covered by the drawdowns and can add up quickly if you're not prepared.

Call one of our team or book an appointment at a time that works for you to discuss how a construction loan can be structured for your investment project and which lenders offer the most suitable terms for your situation.

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