A construction loan lets you fund a new investment property in stages, but you carry the repayments for months before any rent arrives. For investors in Blacktown and Epping, the decision comes down to whether the benefits of building outweigh that gap in income and the risk of costs rising mid-build.
This article covers the advantages, the risks, how staged payments work, and what lenders look at before they approve a build. You can also read our overview of construction loans for the basics.
What Are the Advantages of a Construction Loan for an Investment Property?
The main advantages are that you only pay interest on the money released so far, and that you can build a property to suit tenants. Construction finance releases funds in stages, so your early repayments are smaller than they would be on a fully drawn loan.
Building new also gives you control over design, layout and inclusions. A land and construction package or a separate land purchase followed by a build are both common paths. Depending on your lender, you may be able to choose interest-only repayments during the build, which keeps cash flow manageable while the property is not yet earning income.
Another benefit is flexibility. A broker can compare construction loan options from banks and lenders across Australia, which matters because policies on deposits, builder requirements and loan terms differ between lenders.
What Are the Disadvantages and Risks of Building an Investment Property?
The biggest disadvantages are no rental income during the build, possible delays and costs that rise above the original quote. Each of these can strain your budget while you still pay interest on what has been drawn.
A fixed price building contract reduces the risk of cost blowouts, but variations you request, or site problems, can still add to the price. You are responsible for those extra costs, and a lender will not necessarily lend more to cover them. Many investors keep a buffer for this reason.
The construction loan interest rate can also differ from a standard investment loan rate, depending on the lender. Once the build is finished, the loan usually converts to a standard loan, so it is worth checking the rate and fees that apply after that point. Ask your accountant how construction costs and interest are treated in your situation, as we cannot give tax advice.
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How Does Progressive Drawdown Work on a Construction Loan?
Progressive drawdown means the lender pays your builder in stages as each part of the build is completed, and you pay interest only on the amount drawn so far. The stages are set out in your progress payment schedule, which is part of the building contract.
As an illustrative example, consider an investor in Blacktown who already owns the land and takes out a $400,000 construction facility to build a rental home. The example rate is 6.75% p.a., and the loan is interest-only during the build.
After the slab stage, the builder claims $120,000. Before paying, the lender usually arranges a progress inspection to confirm the work is done. Interest on $120,000 at 6.75% p.a. is about $675 per month. By the final stage, the full $400,000 is drawn, and interest-only repayments rise to about $2,250 per month.
The outcome is that the investor's repayments grow gradually instead of starting at $2,250 from day one. The trade-off is that the investor still needs to cover the higher repayments from other income for the final months, because no tenant is paying rent yet. Interest-only repayments also do not reduce the loan balance. Once the build finishes and the loan converts, principal and interest repayments would be higher than interest-only. You can test different amounts with our mortgage repayment calculator.
Some lenders also charge a fee for each progress payment, so ask about this when you compare products.
What Lenders Look for in a Construction Loan Application
Lenders want to see that the build is approved, the builder is reputable and your income can cover the repayments while the property earns nothing. A construction loan application is usually more detailed than one for an established property.
Expect the lender to ask for a fixed price building contract with a registered builder, along with the plans and the necessary council approval. The lender will also look at your borrowing capacity using your existing debts and income, not just the future rent. Lenders assess whether your income can service the loan while the property earns no rent.
It helps to settle these points with your builder before applying:
- The payment stages and what work each one covers
- How variations are priced and approved
- How long the build is expected to take
Lenders often require the build to start within a set period after approval, so a slow council process can create problems. Allow time for approvals before you lock in your finance.
If you are weighing up building against buying an established property, our investment loans page explains how lenders assess investors. Our local brokers in Blacktown and Epping can talk you through the process.
Call one of our team or book an appointment at a time that works for you, and we will help you work out whether a construction loan suits your investment plans.
Frequently Asked Questions
How does a construction loan differ from a standard investment loan?
A construction loan releases funds in stages as the build progresses, and you pay interest only on the amount drawn. A standard investment loan is usually paid out in full at settlement.
Do I pay rent-free repayments during construction?
You still make loan repayments during the build, but there is no rental income until the property is finished and tenanted. Many lenders offer interest-only repayments during construction, depending on the product.
What happens if the build costs more than quoted?
A fixed price building contract limits the risk, but variations and site issues can still add costs. You are responsible for these extras, so it helps to keep a buffer.
Does a lender inspect the build before paying the builder?
Lenders usually arrange a progress inspection before releasing each payment, to confirm the work for that stage is complete. Some also charge a fee per progress payment.
