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A guide to new-build construction loans

Buying a house off the plans that hasn’t been built yet can seem pretty scary. You’re usually signing up to a massive new-build loan for something with thousands of components that doesn’t even exist yet. How do you know what the finished home will be worth and whether you’ll end up getting what you expected?

The good news is there are several advantages to building a new home and a range of construction contracts that help to ensure everyone is seeing the same finished home. In fact, a construction contract is required in New Zealand if you want a loan for any residential building work costing $30,000 or more.

Each type of contract provides a different degree of certainty over the detail of what you’re getting and what the final cost will be. As you can imagine, the degree of certainty will also affect how much of the expected cost a loan provider is willing to lend and how much your deposit will be. 

To help you get started with choosing the best way forward, here are some of the reasons people prefer to build a new home and a quick summary of the main types of construction contract.

Benefits of building a new home

Everyone has their own reasons for buying a home off the plans, but they usually include some of the following.

Layout control

You can get a floor plan that suits the way you like to live and your future goals, without having to endlessly shop around, make compromises or renovate.

Low maintenance

With a new home everything is brand spanking, so your maintenance bills will be next-to-nothing at first, allowing you to focus on repaying your loan as quickly as possible.

Healthy and economical

New-build homes can include the latest innovations in home ventilation, insulation and heating. Passive heating from the sun, double glazing, heat and sound-controlling insulation, smart systems, and power and internet connections to suit a modern lifestyle can all be optimised from day one.

Low deposit mortgage

Depending on the type of construction contract you choose, for most new-build homes you won’t need a 20% deposit like you do for an existing property. If you’re building the home to live in, you’ll probably qualify for a 10% deposit loan or, in some circumstances, as low as 5% if you’re a first home buyer.

Types of construction contracts

When you’re building a home, the details in the construction contract are vitally important. Before signing anything, it pays to get advice from a lawyer with new-build experience. To avoid nasty surprises later on, make sure you understand all parts of the contract and check that everything about the build is included.
What are PC sums?

It’s not always possible to cost everything precisely before the build begins. You might not have decided about some finishing details or some things may not be known until after construction begins, such as the nature of the sub-soil uncovered by excavation. These costs may be estimated in the contract and referred to as provisional cost (PC) sums, which means they’re not fixed prices.

Here’s a summary of the different construction contract types to help you get started. Their main difference is the degree of certainty they provide around the final cost.

Turn key construction contracts

The word turn key is used to describe a product or service that’s ready to be used immediately. A turn key construction contract details a property that will be fully finished. It includes things like flooring, painting, major landscaping, paths, driveways and more. They’re usually offered by larger construction companies for complete house and land packages, typically in a new development. With very few estimated PC sums, if any, it’s as close to a fixed price contract as you’re likely to get.

Maximum price certainty
Turn key contracts for new-builds provide maximum certainty for you, the homeowner. However, the builder risks losing money if things become more expensive than expected. Builders usually manage this by having a range of previously-costed and built plans you can choose from. They may also build an allowance for some cost over-runs into the price.
Low mortgage deposits

Turnkey contracts aren’t bound by the Reserve Bank’s rules that require a deposit of at least 20%. Loan providers, such as banks, are allowed to lend up to 90% of a turnkey contract price, which means your deposit could be as low as 10%. In some situations, they may even lend up to 95%. If you’re short on savings for a deposit, but have an income high enough to support the regular repayments on a 90% or 95% loan, this type of contract could be just what you need.

Loan payments don’t start until it’s finished

The other advantage of turn key construction contracts is you pay a deposit at the beginning, then your construction loan repayments and mortgage interest charges don’t start until the property is completed and settled. That can give you some time to increase your savings to cover some of the initial moving-in costs, such as insurance, rates and essential furniture.

Build-only construction contracts

These contracts usually apply if you bought your land separately and are engaging a builder to construct your new house on it. You may have more freedom to customise the home to your needs, ranging from variations on a construction company’s standard plans, to hiring an architect to design the house of your dreams. You may also agree to do some of the work yourself, such as painting or landscaping.

Price certainty can vary
Build-only contracts can offer the certainty of a fixed price, like a turn key contract, or they can include any number of estimated PC sums. Either way, it’s very important to understand what is and isn’t included in the contract, even if it has a fixed price.
Progress payments are made during the build
The main difference compared to a turn key contract is when you make payments. Build-only contracts will include a schedule of the progress payments you’ll have to make from your construction loan. They’re usually percentage payments linked to various stages of completion. For example, this might mean up to 20% once the site works and foundations are complete, the various permits are obtained and fees are paid, including the architect’s fees. Another 20%-30% might be due once exterior and interior framing is complete and the roof is on. Payments continue for other stages, with something like the final 10% only being due once the property receives a code of compliance certificate from the local council.
Lending is staged to match the payments
To allow for these staged payments, construction loan providers will give you prior approval for the eventual total loan and let you draw down (borrow) the required payments as they’re due. Before each drawdown, they may require independent certification that the agreed work has been completed to a suitable standard. This ensures the lender can recover their money if construction stops for any reason and you’re unable to make the home loan repayments for the money you already owe.
Interest-only payments during construction

Most lenders will treat the growing mortgage as an interest-only loan during construction and switch to interest-plus-principal repayments once the home is complete. These construction loans normally have a variable (floating) interest rate. You can usually change to a fixed interest rate home loan once everything is complete.

Low deposits may be possible
It may be possible to qualify for a 10% deposit construction loan, particularly if the contract has a fixed price with minimal PC sum costs. However, a 20% deposit is often required. As the estimated PC sum costs increase, the home loan provider may reduce the amount they’re prepared to pre-approve, so there is an allowance for the increasingly likely cost over-runs.
Partial-build construction contracts
These contracts occur when more than one person or business is involved in the build. So, you or a project manager might manage separate quotes and contracts with a wide range of tradespeople, from an earth worker, drain layer and concrete layer to a carpenter, roofing contractor, flooring installer, kitchen installer or landscaper. Some might even be labour-only contracts, where you source the materials yourself. You may also choose to do some of the work yourself, such as painting.
More complex and risky
This approach is not recommended unless you have considerable experience with substantial renovations or new-builds. The likelihood of expensive delays and cost over-runs is high.
Higher deposits are required
Depending on the contracts involved, your construction loan provider will typically only lend between 65% and 80% of the finished home’s expected value, less a 10%-20% allowance for cost over-runs – these types of contracts almost always exceed their budget.
There’s a lot of paperwork

Lenders typically want to see a floor plan with specifications, as well as quotes for all contractors and materials, before they’ll approve a mortgage. You’ll have to provide a payment schedule, and then copies of invoices to be paid, before each staged drawdown of your construction loan is approved.

Valuations will almost certainly be required at each stage, so the lender can identify cost over-runs as early as possible. They’re not trying to be difficult; they just have a responsibility to ensure they can recover their money if things go wrong during construction and you can no longer meet your home loan repayments.

Relocatable and pre-built home construction contracts
Relocatable contracts refer to existing (older) homes that are relocated onto a section you already own or have recently purchased. Prebuilt or prefab contracts refer to a new-build that’s partially or fully built in a factory and trucked to your section. The term kitset home is sometimes used for partially complete pre-builds.
Quicker and more tangible
All of these options can be faster and more straightforward to complete, although older relocatable homes may require a lot of finishing or renovation work. You can see a relocatable before you buy it and pre-built home companies usually have showhomes you can explore. However, there may be limited designs available and few options for customisation.
There’s still work to be done after delivery
In all cases it’s important to check whether the contract includes earthworks, fixing the home to the land and connecting all services, such as water, stormwater, sewerage, electricity, phone and internet. Once again, be sure to check what is fixed price versus an estimated PC sum, so you can allow for cost over-runs.
Lending restrictions apply
In most cases, construction loan providers will require a substantial deposit and only lend based on the value of the land. Because of the risks involved in transporting and locating the home onto your section, they’ll only let you draw down (borrow) the money after the house is attached to the land and connected to all services. Be sure to check how this compares to when the builder requires payment.
Most of the paperwork is still required
Lenders will typically need copies of all contracts and their associated costs or quotes before pre-approving a home loan for a new build. They will also want to see relevant documents, like the sale and purchase agreement for the section, the builder’s insurance cover, initial and staged valuations, and building and council consents.

Final tips

  • Take time to understand the various types of construction contracts, and weigh up the pros and cons of each for you and your situation
  • Organise a support team, such as a friend who has built before, a lawyer, a builder and a project manager if the builder’s not acting as one
  • Make sure your builder is a Registered Master Builder, certified builder or licensed building practitioner
  • Check your finances, create a realistic budget and include an allowance for the inevitable over-runs and unforeseen expenses
  • Talk to mortgage providers and brokers as early as possible to find the best deal, get an idea of how much you could borrow and find someone you feel will help you through the entire process
  • Be aware that some lenders may be offering special low mortgage rates for the first few years if you’re building a new house
  • Don’t sign anything until your lawyer has reviewed it and you understand every detail
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