Welcome to our channel. A few weeks ago, we introduced ANZ’s new policy that benefits small-scale development projects. After that, a lot of clients showed high interest in construction loans. However, we noticed that many clients focus only on construction loans but are not aware of the importance of preparation in the early stage of the project.

Today, we are going to bring some tips for the preparations before making a construction loan. Many possible issues can be avoided if we can make good preparation.

What you need to be aware of before applying for a construction loan? 

Timeline:
1. Tips for who have owned properties to be developed - 01:16
2. Tips for who needs to purchase a property that has development potential - 03:52
3. Equity release lender - 08:17

Tips for those who have owned properties to be developed.

If you have purchased a property and want to develop it, it is better to review its loan structure as early as possible. If you have other properties mortgaged to the same bank as the property to be developed, they might cross guarantee each other.

The consequences of this could be:

  1. It might be hard to meet the lender’s criteria for LVR when applying for a construction loan because you have a certain number of existing loans.

  2. Your finance cost will increase if the bank does not agree to discharge the property. In this case, you need to take all properties and mortgages to a new lender for the construction loan. If you borrowed from a non-bank lender, the finance cost will be even higher.

  3. The risk of other assets will increase. When properties cross guarantee each other, if the development project has anything that goes wrong, all the properties will be affected.

So, it is best to keep the property to be developed separate from your other properties before applying for a construction loan. What you can do is to discharge the property to let it be mortgage-free if you can or keep it standalone with the minimum loan by refinancing other properties to another lender. 

Tips for those who need to purchase a property that has development potential: 

  1. Do good due diligence

Before purchasing the property, it is highly recommended to do good due diligence and make sure that you understand different design options, and the rough costs and margins of each potential design.  If the profit margin is too small, you may not be able to develop the property straightaway because the project is too risky for you and will also not be accepted by the banks.  As a result, you may have to land bank for a while till the margin grows big enough, and there will be a huge cost to hold the property in the long run.

  2. Choose a right lender

If your development project is feasible, you can settle with both bank and non-bank lenders as an equity release lender. One lender may or may not be suitable for you depending on a lot of criteria:  

• Entity’s GST status

Let’s say if you want to purchase a property under a company, then you need to declare if the company is GST registered or not. If it is, the banks will know it’s going to be used for development because a normal property is not GST-attached. Then your loan application will not be accepted by the home loan department of the banks.

• Other usable equities

If your property to be developed has been registered for GST, but you have another property that is useful to top up the funds to settle the property, the banks can still accept your application. 

• Servicing ability

Banks value borrowers’ income very much. If your income cannot meet the norms of the loan, the banks will not consider your application. Then you have to consider non-bank options. 

• Ownership structure

If you want to purchase the property yourself or with your family members, it should be fine. But if you are going to purchase the property with your business partner, it is hard for you to borrow from the banks because the way banks assess your partner’s servicing and yours is different from when they assess only your family’s. The banks will test each applicant if they can service the whole loan alone. Therefore, it is harder to meet the criteria when you are in a multiple household situation.

On the other hand, you and your business partner normally prefer to use the property to be developed instead of your own properties as security for the loan. So, when you and your partner own the property together, you are more likely to choose non-bank lenders.

3. Settlement date

If your settlement date is late enough, you will have a long time to make preparations for the dwelling after signing the unconditional offer before the settlement. According to the scale of your project, you may need six to twelve months to get the design, consents, and agreements ready. If you borrow from a non-bank lender, the longer preparation time can help you save a huge finance cost.

Equity release lender 

Since most people are more familiar with borrowing from banks but feel strange about using non-bank lenders, we would like to introduce the situation when you choose a non-bank lender as your equity release lender. 

 1. The equity release lender does not have to be the same as the construction loan lender.

After the pandemic, housing price is hard to predict, and the construction industry becomes riskier. As a result, fewer non-bank lenders are willing to lend to construction projects, and more of them prefer to provide equity release loans. In fact, the lenders who provide equity release loans and construction loans do not have to be the same. It is fine if you apply for these loans from different lenders. Therefore, when applying for an equity release loan, the cheaper it is, the better.

 2. Make sure your loan term is long enough.

Usually, the finance costs of some equity release loans for a few months and a year are the same. Your ideal loan term depends on how long it takes you to transfer to a construction loan. If your equity release loan expires but you have not been ready to transfer to a construction loan, you need to pay an extra fee for an extension. Therefore, you would be better to estimate how long it will take to get all the consent, and we suggest you add some buffer to that to prevent some unexpected delays. 

 3. Interest payment methods.

There are two methods that you can choose to pay the interest— one is to pay the interest monthly, or you can choose to capitalize interest, which means all the interest will be added to the loan.

Sometimes you have no option if your servicing ability is not enough. The lenders may require you to capitalize the interest. In this case, you will have less money for the settlement because a portion of the loan is used to cover the interest cost during the loan term.

 4. LVR

If you are not going to demolish the house during the loan term, usually, the lender can include the dwelling and its improvement value when they work out the LVR. And if you are GST registered, they will take out the GST from the value. Normally, 60% LVR is ideal, but if you consider borrowing more, a higher finance cost will be generated.

 5. Exit strategy

The normal exit strategy is to refinance to a construction loan lender. Therefore, before you repay it, you need to work out the next step about who will provide you with the construction loan, and the loan should include the existing lending for the settlement.

 6. Security

In terms of security, you need to put some assets to mortgage the loan, including:

• First Mortgage,
• Personal guarantee,
• GSA over the entity 

Other tips

If you are looking to purchase a property for development, make sure that you have decided before you purchase. It is good to talk to professionals, such as town planners, or real estate agents, to work out different plans and understand which option is better. They understand what design is popular and the trend of demand in the market.

Also, it is necessary to talk to a solicitor and an accountant. With their support, you can set up the right loan structure upfront to avoid certain issues such as changing ownership in the future.

If you have further questions or difficulties in your loan, please feel free to contact us, we are more than willing to help you!

Read more:

Great news for small property development project

CCCFA will make it harder for people to get loan approval?

The four challenges in property development

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.