How Construction Loans Work — Progress Payments, Stages and Real Risks to Watch

If you are weighing up a house‑and‑land package or a major rebuild, a standard home loan will not work for you. Construction loans are designed for this exact situation — where the builder needs to be paid in stages as the work is completed, not in one lump sum at settlement.

How a construction loan works

Instead of handing over the full loan amount at settlement, a construction loan delivers the funds in a series of progress payments that line up with the building contract. Each payment is drawn down only after the work for that stage is finished to the lender’s satisfaction. This means you only pay interest on the money that has been drawn so far, not on the whole loan amount, which helps keep interest costs lower during the build.

The construction loan is normally set up as an interest‑only loan while the build is underway. Once construction is complete and the final progress payment is made, the loan usually reverts to a standard principal‑and‑interest home loan, and your regular repayments will increase.

The progress payment process

The stages — and the percentage of the total loan paid at each stage — are set out in a progress payment schedule that is part of your fixed‑price building contract. A typical schedule looks like this:

Stage	Common payment	What triggers the payment
1. Deposit	5%	Signing the building contract (your own savings usually cover this, not the construction loan)
2. Slab / base	15–20%	Concrete slab poured and cured
3. Frame	20–25%	Wall and roof framing complete
4. Lock‑up	20–25%	Windows, doors, brickwork or cladding finished; the house is secure
5. Fixing / rough‑in	15–25%	Plasterboard, architraves, plumbing and electrical rough‑ins installed
6. Completion	10–15%	All work finished, final handover and practical completion certificate issued

The percentages vary between builders and lenders, but the flow is largely the same. An important detail: lenders may retain a small percentage of each drawdown until the final stage as added protection.

Valuations at every stage

Before each progress payment is released, the lender will arrange a valuation to confirm the work has been completed in line with the contract. This is not a full property appraisal — it is a short inspection to check the stage is genuinely finished and the value of the work done supports the next drawdown. If the valuation does not match the building contract’s stage completion, the payment may be delayed or only partially paid until the builder rectifies the work.

Interest during construction

Because you are charged interest only on the drawn balance, your interest bill starts small and ramps up as the build progresses. In the early months it might feel manageable, but once the frame and lock‑up stages are paid, the balance — and the monthly interest charge — can rise quickly. Keeping a separate buffer for these growing interest costs is smart.

Many borrowers also need to continue paying rent or their current mortgage while covering the construction loan interest, so the total holding cost can be higher than it first looks.

Key risks and how to protect yourself

Builder delays and insolvency. Delays are frustrating and expensive — every extra month is another month of interest, rent and holding costs. Worse still, if the builder becomes insolvent mid‑build, you may face a partly finished home, a contract with an insolvent company, and difficulty recovering money already paid. While no product can eliminate this risk, you can take steps to limit your exposure:

• Check the builder’s licence and track record before signing. Fair Trading NSW advises you can verify a builder’s licence online and offers resources on resolving contractual disputes.
• Insist on a detailed, fixed‑price building contract with clear timelines and a progress payment schedule that matches the work actually performed.
• Understand what your construction loan insurance (often called builders warranty insurance) covers — this is separate from your own home and contents insurance and is designed to cover incomplete or defective work if the builder dies, disappears, or their licence is suspended. Check the relevant state‑based schemes and talk through the cover with your lender and broker.

Cost overruns. If the build costs more than the contract price, the construction loan will not automatically cover the difference. You will need to fund any extra costs yourself, either from savings or by seeking a variation to the loan — which is not guaranteed and can be delayed. A realistic contingency fund is essential.

Valuation shortfalls. If the lender’s valuation comes in lower than expected at any stage, the loan amount may be reduced. This can leave you with a funding gap even if the builder has done the work. A carefully structured loan and a conservative budget can help mitigate this risk.

How Arrivau can help

As a licensed Australian mortgage broker, Arrivau can help you compare construction loan options from different lenders, explain the progress payment mechanics, and work through the risks and requirements with you. We will ask about all the moving parts — your building contract, contingency buffer, living arrangements during the build, and how you plan to handle the interest‑only period — so you can make an informed choice.

The information here is general in nature and does not constitute personal financial advice. Arrivau Pty Ltd provides credit assistance under its Australian Credit Licence. Arrivau is not a lender, does not promise loan approval, specific interest rates, savings or any financial outcomes, and does not claim to be an insurer or underwriter. Before making any decisions, speak with a solicitor or conveyancer about your building contract and with a licensed broker about your borrowing situation.

For reliable background on the building process and your rights, visit Fair Trading NSW’s Building or renovating resources.