What a Construction Loan Covers When Building Custom
A construction loan provides funding in stages as your custom home gets built, with lenders releasing money at specific milestones rather than handing over a lump sum at settlement. You only pay interest on what's been drawn down, not the full loan amount.
Consider a couple purchasing vacant land in Bentleigh for $850,000 with a building contract valued at $620,000. The lender approves total funding of $1,470,000 but releases it across five progress payments tied to slab, frame, lock-up, fixing, and completion stages. During the frame stage, they're paying interest on roughly 40% of the total loan, not the full amount. That difference can mean $1,800 to $2,400 less in monthly interest during early construction compared to if the full loan was active from day one.
Most lenders structure construction loans as interest-only during the building phase, switching to principal and interest repayments once you move in. The interest-only period typically runs for 12 months, though some lenders extend this if construction takes longer than anticipated.
Fixed Price Contracts and What Lenders Require
Lenders funding custom home construction will only work with a fixed price building contract from a registered builder. That contract needs to specify the total cost, include a detailed scope of works, and outline a progress payment schedule that aligns with construction milestones.
The contract protects both you and the lender. If a builder quotes a range or uses a cost plus structure where final costs depend on materials selected later, most mainstream lenders won't proceed. They need certainty around the loan amount before approving finance. Your builder also needs appropriate insurance and licensing valid in Victoria, which the lender will verify during assessment.
You'll typically need to commence building within six to 12 months from the loan disclosure date. If you delay beyond that window, the lender may reassess your financial position or withdraw the approval altogether. That timeline matters if council approval takes longer than expected or if you're waiting for a specific builder's availability.
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The Progressive Drawdown Process
Progress payments get released after each construction stage is inspected and certified. Your builder requests payment, the lender arranges an inspection, and once the stage is verified as complete, funds get transferred directly to the builder within a few business days.
Most lenders charge a progressive drawing fee each time funds are released. That fee usually sits between $300 and $450 per drawdown, meaning across five stages you'll pay $1,500 to $2,250 in administration costs on top of your standard loan fees. Some lenders cap this fee or waive it depending on loan size, but it's a line item that catches people off guard if they haven't budgeted for it.
The number of drawdowns varies by lender, typically ranging from four to six stages. More stages mean more granular control over fund release but also more inspection fees. Fewer stages mean less administration but larger gaps between payments, which can create cashflow issues for smaller builders who pay sub-contractors weekly or fortnightly.
Land Purchase Settlement and Holding Costs
You'll settle on the land before construction starts, which means you'll be paying interest on that portion of the loan while waiting for the build to commence. If land settlement happens in July and construction doesn't start until September, you're covering two months of interest on the land loan before the first progress payment is even drawn.
In a scenario where someone purchases land in Reservoir for $620,000 with a 10% deposit, they're paying interest on roughly $558,000 during that holding period. At current variable rates, that's close to $2,800 per month before construction begins. If council approval or builder availability delays the start by three months instead of one, that's an extra $5,600 in costs that weren't accounted for in the original budget.
Some buyers retain their existing rental or living arrangement during construction to avoid double housing costs. Others move in with family temporarily. Either way, the holding cost between land settlement and construction commencement needs a line in your budget, particularly if you're building in areas where council plans take longer to process.
Deposit Requirements and Genuine Savings
Lenders typically require a 10% to 20% deposit for land and construction packages, calculated against the combined value of land and building costs. If you're borrowing more than 80% of the total project cost, you'll pay lenders mortgage insurance and face stricter serviceability requirements.
Genuine savings expectations apply the same way they do for established property purchases. If you're a first home buyer accessing a government guarantee scheme, deposit requirements may drop to 5%, but the lender will still want to see consistent savings history and stable employment.
Your deposit also needs to cover upfront costs that sit outside the loan, including stamp duty on the land, conveyancing fees, building insurance, and the initial progress payment if the builder requires a mobilisation deposit before the lender's first drawdown. In Victoria, stamp duty on an $850,000 land purchase is approximately $45,000, which most lenders won't include in the loan amount.
How Construction Loan Applications Get Assessed
Lenders assess construction loan applications based on the total project value, not just the land price. Your borrowing capacity needs to support the combined land and building cost, plus demonstrate you can service the loan once it converts to principal and interest repayments.
Serviceability calculations assume the full loan amount is drawn and repaying at principal and interest rates, even though you'll be paying less during construction. That means if your income can only just service the land component, you won't get approval for the build. The lender tests against the end position, not the construction phase.
You'll need council-approved plans before most lenders issue formal approval, though some will provide conditional approval based on draft plans if you're still working through the development application process. Once council approval is finalised, you'll need to provide the stamped plans, the building contract, and proof of builder insurance before the loan can settle.
Interest Rate Structures During and After Construction
Most construction loans start on a variable interest rate during the building phase, switching to either variable or fixed once construction completes and you move in. Some lenders let you lock in a fixed rate from the start, but you'll pay interest on the full loan amount from day one rather than only on progressive drawdowns.
The difference in cost is significant. If you fix the rate upfront on a $1,470,000 loan, you're paying interest on that full amount immediately. If you stay variable during construction, you're only paying interest on what's been drawn at each stage. Over a 12-month build, that can mean $15,000 to $22,000 in saved interest, even if the variable rate is slightly higher than the fixed option.
Once construction is complete, you can refinance or restructure your loan without penalty. That gives you the option to move to a fixed rate or split your loan between fixed and variable portions depending on where rates are sitting at the time. If rates have moved significantly during your build, refinancing into a more suitable product might make sense within the first six months of completion.
Owner Builder Finance and Why It's Harder to Secure
If you're planning to act as an owner builder rather than engaging a registered builder, your finance options narrow considerably. Most mainstream lenders won't provide construction finance to owner builders due to the increased risk of cost blowouts, delayed timelines, and incomplete work.
The few lenders that do offer owner builder finance require significant construction experience, a detailed project plan, evidence of trades already engaged, and a higher deposit, usually 20% to 30%. Interest rates are also higher, and the loan amount is typically capped at 70% to 80% of the combined land and construction value.
If you're set on managing the build yourself, expect to fund a larger portion from your own savings and accept a smaller loan at a higher rate. For most people building a custom home in Melbourne, engaging a registered builder and accessing standard construction finance delivers lower overall costs and less financial exposure, even after paying the builder's margin.
Variations, Cost Overruns, and What Happens When Plans Change
If construction costs increase mid-build due to variations or unforeseen site issues, your lender won't automatically increase the loan amount. Any cost above the original contract value needs to be funded from your own savings unless you apply for a loan top-up, which requires reassessment and may not be approved.
Variations should be documented in writing and signed off by both you and the builder before work proceeds. The lender will want to see a formal variation agreement if you're requesting additional funds. Verbal agreements or informal changes won't satisfy the lender's requirements, and you'll be left covering the difference out of pocket.
In our experience, cost overruns most commonly occur when buyers make selections outside the builder's standard inclusions or when site conditions require additional earthworks not identified in the initial site assessment. Keeping a contingency buffer of 5% to 10% of the build cost as accessible savings gives you room to manage these changes without derailing the project or delaying progress payments.
Call one of our team or book an appointment at a time that works for you. We'll review your plans, connect you with lenders that fund custom home construction across Melbourne, and structure the loan to match your build timeline and budget.
Frequently Asked Questions
How does interest work during the construction phase of a custom home loan?
You only pay interest on the amount that's been drawn down at each construction stage, not the full loan amount. Most lenders offer interest-only repayments during the build, switching to principal and interest once construction is complete and you move in.
Do I need council approval before applying for a construction loan?
Some lenders will provide conditional approval based on draft plans, but you'll need council-approved plans and a signed building contract before the loan can settle. Most lenders require stamped council plans as part of the final approval process.
What deposit do I need for a land and construction package in Melbourne?
Lenders typically require 10% to 20% of the combined land and building cost. If you're borrowing more than 80%, you'll pay lenders mortgage insurance and face stricter serviceability requirements.
Can I use an owner builder approach and still get construction finance?
Most mainstream lenders won't fund owner builder projects. The few lenders that do require significant construction experience, a higher deposit of 20% to 30%, and charge higher interest rates with reduced loan amounts.
What happens if my building costs increase after the loan is approved?
Lenders won't automatically increase the loan amount for variations or cost overruns. You'll need to fund the additional cost from your own savings or apply for a loan top-up, which requires reassessment and may not be approved.
