Construction loans and progress payments explained

A construction loan funds the building of a home rather than the purchase of a completed one. Instead of advancing the whole amount at settlement, the lender releases funds in stages as the builder completes defined milestones, and charges interest only on the amount drawn at any time.

The structure is well established and works reliably, but it differs from an ordinary home loan in ways that affect cost, timing and risk. It also places the borrower between a lender and a builder, each with its own requirements, and managing that relationship is a significant part of the work.

How a construction loan differs from a standard home loan

Feature	Standard home loan	Construction loan
How funds are advanced	In full at settlement	In stages as work is completed
Interest charged on	The whole balance from day one	Only the amount drawn to date
Repayments during the build	Not applicable	Usually interest only
Valuation basis	The property as it is	The property as it will be on completion
Documents required	Contract of sale	Fixed price building contract, plans, specifications, council approval, builder's insurance
Time limit	None	A construction period, commonly 12 months, after which the loan converts

The loan usually has two phases. During construction it is interest only on the drawn balance. On completion it converts to an ordinary principal and interest loan for the remaining term.

The building stages

Progress payments follow recognised construction stages. The names are broadly consistent across the country, and in Victoria the maximum percentage payable at each stage is prescribed by section 40 of the Domestic Building Contracts Act 1995, unless the parties contract out of it in the manner the regulations require.

Stage	What is complete	Victorian prescribed maximum
Deposit	Contract signed	5 per cent
Base	Footings, stumps or the concrete slab	10 per cent
Frame	Frame erected and inspected by the building surveyor	15 per cent
Lock-up	External walls, roof, external doors and windows in place	35 per cent
Fixing	Internal linings, doors, cabinets, skirtings and fixtures installed	25 per cent
Completion	Work finished and the home ready for handover	The balance, commonly 10 per cent

Other states do not all prescribe the percentages, but the stages and the general distribution are similar. The pattern matters: the largest single payment falls at lock-up, so the drawn balance, and therefore the interest charged, rises steeply in the middle of the build rather than evenly across it.

Before releasing each payment the lender generally requires the builder's invoice and, for most stages, a progress inspection confirming the work claimed has actually been done. The inspection protects the lender rather than the borrower, and it is not a quality inspection. Owners who want the work checked on their own behalf engage an independent building inspector separately.

Interest during construction

Because interest is charged only on the drawn balance, the total cost during the build is far lower than it would be if the whole loan were advanced at the start. The following is illustrative only, at an assumed construction rate of 6.50 per cent, with land of $300,000 settled at the beginning and a build contract of $500,000 drawn over twelve months following the prescribed stage percentages.

Month	Drawn that month	Cumulative drawn	Interest that month
1, deposit	$25,000	$325,000	$1,760
3, base	$50,000	$375,000	$2,031
5, frame	$75,000	$450,000	$2,438
7, lock-up	$175,000	$625,000	$3,385
9, fixing	$125,000	$750,000	$4,062
11, completion	$50,000	$800,000	$4,333

Across the full twelve months, interest totals roughly $36,021. Had the entire $800,000 been drawn from the first day, interest at the same rate would have been about $52,000. The staged structure therefore saves roughly $16,000 on these assumptions.

The figure that matters to a household budget, however, is not the saving but the outgoing. Interest of about $36,000 over the year is roughly $3,000 a month on average, rising from about $1,760 in the first month to about $4,333 in the last. A household that is also paying rent during construction must fund both, and the interest cost increases every time a stage is drawn. On completion, the $800,000 loan converted to principal and interest at an assumed 6.00 per cent over 30 years requires about $4,796 a month.

The mortgage repayment calculator can be used to model the converted loan, and the borrowing power calculator to check that the eventual repayment is serviceable.

The fixed price building contract

Lenders require a fixed price building contract with a licensed or registered builder, containing a progress payment schedule aligned to recognised stages. Cost plus contracts, under which the owner pays the builder's costs plus a margin, are generally not accepted, because the final cost is unknown and the lender cannot size the loan.

A fixed price contract is nonetheless not always a fixed cost. Common sources of variation include:

• Site costs, where the contract contains a provisional allowance for excavation, rock removal, soil classification or drainage, and the actual cost exceeds it.
• Provisional sums and prime cost items, which are allowances for items not yet selected, such as appliances, tiling or landscaping. If the selection exceeds the allowance, the owner pays the difference.
• Variations requested by the owner, which are often the largest single source of overruns.
• Rise and fall clauses, where permitted, allowing the price to move with material costs.
• Items excluded from the contract, such as driveways, fencing, letterboxes, floor coverings, window furnishings and landscaping. These are frequently not financed and must be funded separately.

Lenders will usually not increase a construction loan mid build to cover variations, or will do so only through a full reassessment. A contingency of at least five per cent of the build cost, held in cash or in an approved facility, is a sensible precaution.

Valuation on completion

A construction loan is assessed against the on-completion value, which the valuer estimates from the plans, the specifications and the building contract. Two issues arise.

The first is that the on-completion valuation may be lower than the total of land plus build cost. This happens most often on unusual designs, on high specification builds in modest areas, and where land was bought at a strong price in a market that has since softened. The loan is sized on the lower figure, and the borrower funds the difference.

The second is that the valuation is done at the outset but the loan converts on completion, by which time the market may have moved. Most lenders do not revalue at completion for the purpose of the original loan, which works in the borrower's favour if values have fallen, but a borrower wanting to refinance or release equity afterwards will be assessed on a fresh valuation. The guide to property valuations for home loans explains the types used, and the loan to value ratio guide sets out how the ratio is calculated.

Stamp duty on building

Where land and construction are contracted separately, transfer duty is generally assessed on the land alone rather than on the completed house. On a $300,000 land and $500,000 build, duty is calculated on $300,000, which is substantially less than duty on an $800,000 established home. Several states also direct first home buyer relief specifically at new construction.

The saving depends on the contractual structure rather than on marketing. Where a single contract obliges the buyer to take a completed dwelling, revenue offices will generally assess duty on the full value, and anti-avoidance provisions apply to arrangements structured to appear separate when they are not. A conveyancer should confirm the position before contracts are signed. The state by state position is set out in the guide to stamp duty on property purchases.

Builder insurance and consumer protection

Every state and territory operates a statutory scheme requiring builders to hold insurance for residential building work above a threshold value, providing cover where work is incomplete or defective. The schemes differ significantly in name, trigger and limit.

Victoria replaced Domestic Building Insurance with a Home Warranty scheme from 1 July 2026. The Building and Plumbing Commission is the sole provider, cover is mandatory for domestic building projects up to three storeys valued above $20,000, the maximum cover is $400,000, and consumers are automatically covered on entering an insurable domestic building contract even where the builder has not paid the premium. Materially, it operates as a first resort scheme: cover extends to incomplete, defective or non-compliant work where the builder is unable or unwilling to complete or fix it, rather than only where the builder has died, disappeared or become insolvent.

Other jurisdictions operate their own schemes with their own triggers and caps, and several exclude buildings above a certain height. Before signing, a borrower should confirm the builder's licence or registration with the relevant state regulator, confirm that the required insurance is in place for the specific project, and retain the certificate.

Knockdown rebuilds, renovations and owner builders

Not every construction project fits the standard house and land model, and three variations are worth distinguishing.

A knockdown rebuild on land the borrower already owns is financed in much the same way, with the existing equity in the land taking the place of a land purchase. The complication is that demolition reduces the value of the security before it increases it, so lenders assess the on-completion value and will generally want the existing mortgage restructured rather than simply topped up. Where the existing dwelling is being demolished, the borrower also needs somewhere to live for the duration, which is a real cost that should be budgeted alongside construction interest.

A major renovation may be financed by a construction loan where the work is structural and carried out under a building contract, or by a simple loan increase where it is cosmetic and modest. The dividing line is set by lender policy, generally by reference to whether council approval and a licensed builder are required. A renovation financed as a loan increase is drawn in full and charged interest from the outset, which is more expensive than staged drawdowns but simpler to administer.

Owner builder projects, where the owner takes on the role of the builder, are financed by comparatively few lenders and on stricter terms, commonly at a lower maximum loan to value ratio. Lenders are cautious because there is no fixed price contract, no licensed builder responsible for completion, and in most jurisdictions no statutory warranty insurance covering the owner's own work. Owner builders also face restrictions on selling within a set period without disclosure and, in several states, a requirement to obtain a permit before commencing.

In each case the underlying principles are the same: the lender is assessing a completed property that does not yet exist, and the borrower carries the risk of everything that happens in between.

Risks to plan for

• Delay. Construction periods overrun frequently. Most construction loans allow around twelve months, and an extension may require the lender's approval and a fee. A household paying rent during an overrun pays both rent and construction interest for longer.
• Builder insolvency. The most serious risk, and the reason the statutory insurance exists. Cover is capped and does not compensate for the time lost.
• Cost overruns. Driven mainly by site costs, provisional sums and owner variations.
• Interest rate movements. The construction rate is usually variable, and the eventual repayment depends on the rate at conversion.
• Unfinanced items. Driveways, landscaping, fencing and floor coverings are commonly excluded from the contract and from the loan.
• Disputes over stage completion. Where a lender's inspector and a builder disagree that a stage is complete, funds are not released and work may stop.

Practical steps before committing

1. Obtain the building contract and have it reviewed by a solicitor before signing, including the provisional sums, the exclusions and the variation process.
2. Confirm the builder's registration and insurance with the state regulator.
3. Ask the lender for the construction rate, the interest only period, any progress payment fees and the number of free inspections.
4. Budget the interest during construction month by month rather than as an annual figure, because it rises as stages are drawn.
5. Hold a contingency of at least five per cent of the build cost.
6. Establish what is excluded from the contract and how those items will be funded.
7. Confirm the duty position with a conveyancer before signing land and building contracts.

Building can produce a better result for the money than buying an established home, particularly where duty is assessed on land alone and first home buyer relief is directed at new construction. It also requires more capital buffer, more attention and more tolerance for delay than most buyers anticipate. This article is general information and not legal or financial advice. Those weighing a build against a purchase may request a free assessment from an accredited broker, or read the guide to home loan types.