Construction and Renovation Lending

There are some distinct differences between what banks call construction lending, unfortunately this part of finance has plenty of jargon and buzz words which make it difficult to follow and understand. This is your guide to breaking down the barriers and understanding what you mortgage broker or bank is talking about.

Building a home is not for everyone, busy people or those that don’t like stress may want to avoid this process entirely.

The big stresses that come with a build:

• Time taken to plan
• Manging the budget
• Decision fatigue
• Time delays
• Disputes with builders or sub trades

With each option below some of these stresses are covered off while others expose you totally to all five stresses, there will be more than the five above too.

Topics we will cover off

1. Turn key builds
2. Land & build – new builds
3. Cost and quotes new builds & consented renovations
4. Non consent renovation

Turnkey Builds

These are the simple way to build and are popular with townhouse and apartment new builds due to the intertwined share walls or total building shell that needs to be completed for an apartment block with multiple floors. In saying that standalone homes in leafy suburbs can also be built like this but often you have limited scope to adjust the layout of total floor plan as well as spec. This type of approach allows a builder to provide cookie cutter properties at what are more affordable prices than you would get with an architectural build. Typically you will get to pick minor changes to layout and often colours and furnishing within a palate or a range of products. An example would be Bosch over Fisher and Paykel products for the oven and dishwashers

With this process you pay a 5% or 10% deposit and within 6-18 mths you have your completed home at which point you need to fund the balance of the purchase price.

When it comes to financing these homes it relatively straightforward.

• The deposit can usually be funded via your existing property subject to lending criteria if you don’t have the savings
• Some banks will provide the deposit unsecured if you have the deposit in Kiwisaver
• Approvals are often for 12 months allowing time to complete the project and settle the balance
• You can continue to save while you wait for the project to complete. If this is a first home its often better to use cash or a bank funded deposit rather than withdraw kiwisaver early to cover this cost, the further 12 mths of kiwisaver saving will help with lowering your loan and maybe even getting to a 20% deposit
• In almost all cases banks need a registered valuation to validate the purchase price you have paid. Its often good to get this upfront if the bank is prepared to use that for the full 12 months of the approval. If you wait the property market may drop and result in the lower of the two values being used. Most banks will use the lower of the two values purchase price or registered valuation, it’s a protection they have for you overpaying or the property market dropping in value.
• The developer covers cost overruns and any insurance along the way, its all their responsibility until you take possession.
• Important to note that you complete your visual inspection prior to settlement to make sure they haven’t varied the quality of the products used and the standard of work completed is good. These being massed produced and often constructed to allow as many buyers as possible to buy the attention to detail can be lower. This is not typical of all of these builds as there are luxury apartments and townhouse developments in the market.

Advantages

• Generally no cost overrun risk
• Easy option with less decisions needed on your part
• No double up of interest cost during the build, rent and loan interest 

Disadvantages

• Less ability to bespoke your final home
• Generally a larger project to takes longer to complete
• Market risk of house prices either going up or worse, down while you wait to settle – financing risk

Financing

Super simple, deposit is funded up front of 5% or 10% then the balance is funded on settlement, when the certificate of title is issued (the land become its own entity) and home has building consent signed off. The only real stress is having a short turn around on settlement, 5 working days to settle is often too quick as the property will almost always need a registered valuation completed or a revisit to say its to the spec and standard the original valuation had assumed.

This type of build reflects almost the lowest risk for the bank as there are very few chances of cost increases or issues given its normally an experienced developer completing the project. Therefore most bank only require a 5 or 10 % deposit for an owner occupied home or even 10% for an investment property, you still have to pay low equity fees or margins on your lending. The property is exempt under the RBNZ rules for low deposit lending so LVR can be pushed and you can get a pre-approval

Land & Build package – new build or renovations

These proposals are generally give you scope to build almost any type or style of home at any budget. Traditionally you purchased the land then set about getting a Design completed or picking from a builders set plan, move towards a building consent and then a fixed price contract to build your new home. The sections are sold direct to you and you get to pick the builder to use. More recently we have seen larger building companies take these sections on under builders terms, this is where the building company effectively owns the section and tries to sell on within 3-6 months to a client. They never actually own the land all going to plan but are able to secure the better sections and lock in a build contract which is where they make their profit. It does mean smaller building companies may struggle to compete with the larger operators who can take on more sections and work.

Within these new developments there are often covenants in place to provide some uniformity to the quality of the area. Sometimes they have a minimum size, set backs from the road, prohibit relocating older styled homes.

These types of builds do mean carrying extra cost while you are building as well as possibly requiring you to sell your own home first and rent while you wait for the build to finish. Often you are paying a home loan on the land and then paying interest on the build loan until completion as well as your current loan payment or rent.

Occasionally we see fixed price renovations but these are rare and most builders wont provide them

This can also be applied to lifestyle blocks, only real variation is having to allow for extra costs as follows

1. Power and phonelines to the build site – can be very expensive, we see solar systems as an alternative
2. Your own septic and waste water system
3. Fresh water system – collected from a roof or from a ground bore.

Advantages

• You get to build your dream home and pick your own quality of fitout, paints and layout within your budget
• Build loans are usually interest only for at least 12 months while you build and you only pay the outstanding amount not the full loan amount
• Generally these are used for standalone homes so more space
• Fixed price contract, generally you are only exposed to increases in materials costs rather than time delays or reworks
• Project managed by the builder so really you only have to worry about paying the builder on time and keeping an eye on progress

Disadvantages

• You may be stuck with a build company if they have control over the section you want
• Paying rent or a mortgage while also incurring mortgage payments on a land loan and build loan
• Landscaping and outdoor areas usually need to be paid for on top and are the owners responsibility
• You usually need to arrange contract works or builders risk insurance – this covers loss through the build that isn’t the fault of your builder, for example a fire or weather event damaging the property when its vulnerable

Financing side

Part 1

The land is purchased and is either its paid for with cash or at the very least a 20% deposit. Often we find clients buy land by using the equity in their current home with full loan, they then sell and rent for a period while they complete the build, some are able to hold off selling but that does require a client with a very strong financial position.

Part 2 

Funding the build portion, here the loan is drawn down progressively as you hit stage payments, slab down, frame up, roof on and close in to name just a few of these stages. These loans are interest only for 12 months (expected build time) and you only pay for what you use each month. Once you get close to completion banks will retain normally 5% of the total build budget to ensure you get code of compliance finalised and some banks may require the valuer to revisit and confirm the property has been finished and to the specification on the original valuation. Its important for you to understand what the builder has in the contract you sign here so that there are not arguments at the end. Often we have seen builders have practical completion for final payment but the bank wants to official code issued to ensure any issues are sorted.

These types of projects represent a bit more risk for banks due to variations on the way by owners, upgrades or changing a window or product. Even though its fixed price changes are normally extra charge and with a healthier margin on top for the hassle factor. What we also see if that often landscaping, outdoor areas or soft furnishings are not included so a top up is often needed at the end to cover these extra costs.

Ideally in these types of builds you have 5% of your build budget as a contingency, not essential but a good idea. Banks will often run 10% overrun allowance on your ability to service the loan, if you cant service say an extra $45k on a $450k build then the loan wouldn’t be approved upfront

Cost and Quotes new build or renovations

This is often a clients dream home and is usually with a specialist builder or independent builder. Often the home has an architect involved and the cost per square meter can push well over $10,000 per metre square on average. New Zealand appears to be able to build average cookie cutter big box builds for around $3500 to $4000 per square meter, so these push well past this in quality of products and just man hours to build. Some people use this process to drive down cost while getting a better quality product, they take on the project management risk and can pick and mix subcontractors to get the best deal or most efficient trade. I think we all have seen Grand Designs and seen that it takes a special type of person to do this especially if they have full time work or family commitments.

When it comes to large scale renovations the cost per square meter can go even higher due to the labour costs and what cant be seen behind the walls, often we are told that X wall had the cladding was removed and the framing needs replacing or the footings aren’t  stable. When it comes to renovations adding quite small extra space can push up the per meter cost due to having to stich in new roof angles or just really high costs areas like kitchens and bathrooms concentrates the cost to relatively small extra space. A very modest extension of 25m2 to a living room, with deck and a new ensuite was a $200k cost, so $8k per sm. This was 7 years ago before the huge increase in prices we have seen and that was a 1970s 4 bedroom home.

Advantages

• You get the dream home you always wanted with bespoke features
• Involvement in the process to a high degree
• Some ability to control costs and get a better quality product for the costs
• When it comes to renovation you get the house you want without having to sell your own and move

Disadvantages

• Higher cost due to complexity or products used
• Banks require higher equity levels in general to be comfortable lending.
• Additional checks either upfront or along the way from industry professionals
• Higher chance of cost overruns and at significantly higher proportion
• These can often be on challenging sites with views or in locations where land is scarce, an example would be on the hills overlooking Queenstown or in tight sites in central Auckland with heritage restrictions

These are considered one of the highest risk builds for a banks, where cost blow outs are almost expected.

Some banks restrict the LVR to 70% and most run a 15% overrun allowance on top of what you have budgeted. This is not funded upfront and is a shadow limit to show the banks they can lend you further funds based on your income. Generally banks don’t want part finished projects especially fi they have to mortgagee sell, this detracts significantly from the sale price. This gives them scope to lend more to finish the project, it may still push higher on the loan to value ratio but at 70% to start it gives decent scope to finish. There are some banks that are more relaxed about the LVR and will go up to 80%, most want to stay at this level for a new build. A renovation they may go higher to 90% due to the building platform or base being there.

Here are some key things to understand with this build or renovation

1. Providing as detailed cost and quotes from your project manager or your own work is keep to building confidence with your bank
2. Similar conditions apply with the 5% retention figure, contract works/builder risk insurance on the build budget and valuer visits to confirm completion
3. Some banks will require any costings to be reviewed by a quantity surveyor upfront and even through the project against costs you budgeted for, these professionals check a builder or your costings against industry standards and are an independent check to make sure its realistic. Often a $1m budget is a benchmark for this being requested
4. Valuers will almost always be involved if you are borrowing funds, they value as is and on completion of the project. They reinforce that you aren’t over capitalising the property or the bank understands the true loan to value ratio. A $5m house in an area that the average house price is $450k will likely value less on an open market sale given there may be no one in that area that can buy that home.
5. Often a valuer will have to go out at certain stages normally tied to bank funding and complete progress valuations based on the work done, they show the extra value added from the work as a percentage of the end value and then the bank will advance up to a percentage of that, typically 80% of the progress valuation
6. When a bank looks at the project most will use the lower of these two values As is value plus cost to complete or Registered valuation, here is a working example

Bob owns land worth $500k, he wants to build a home worth $500k, land plus cost to complete $1m. The valuer knows Bob is a builder so is not charging a builders margin and doing it at cost so he thinks its worth $1.1m. the bank will use the $1m value for LVR.

May not seem fair but banks having lent to builders know that they can quite easily up spec a home through the build without much consultation so will in most cases remain more conservative.

Billy owns land worth $500k and he wants to build a $1m home in Eketahuna, its 150m2 and spec’d to the nines with imported Italian tiles and cedar cladding with shist pillars, nothing but the best for his dream home. The cost plus land value has this at $1.5m. The valuer has no other comparable sales at the same spec within 30km and house sales are only 2 a month normally and the last highest price was $900k 2 years ago. They take the approach that it’s the best house in town and that its worth $1.1m. That means that Bill needs to have extra funds in to cover the build.

These require plenty or pre-work and good management through the build process to stick to budget and often tenacity get project completed. Many drag on for years and some renovations probably never get finished

Non consented or cosmetic renovations

These are relatively easy and often if you aren’t right up against 80% LVR on an owner occupied property these can just advanced in one lump sum to you to complete the work, Typically they look like this

1. Kitchen replacement like for like
2. Bathroom refit with no changes to pluming under the home or in the pad
3. Soft furnishing like curtains or carpet
4. Solar installation, heating or cooling systems, double glazing hot water systems
5. General redecoration
6. Repairs and maintenance like a roof replacement or exterior paint

The key here is the need for building consents, LVR level  and with some bank there are dollar volume restrictions in some cases or a combination of all.

Generally if the finance you need is below 80% LVR of your property value as is then it can be advanced in one lump sum. If not you may need an as is and completion valuation to show the work you are doing will add value to maintain you below 80% LVR once completed, you may of course be able to go over that 80% but that has some implications around the bank criteria and the interest rates you will receive or fees paid to the bank. When you get into this situation there may be a need to have what they call a progress payment loan and the valuer may need to visit the site at certain points (refer to the cost and quotes topic above). Funds get advanced in stages or reinspection’s if you need the extra value to stay below 80% LVR ort if the budget is suitably large enough but that is very much case by case with the persons financial position and bank.

Often like for like replacement or certain trade work doesn’t require a building consent, you need to talk to your local council or trade person to determine what’s needed.

What you and the banks should know

• Estimates or quotes often or a basic budget to show some due diligence
• Whether it needs a build consent granted (don’t cut corners here or it will bite you when you sell)
• Most often you don’t need contract works or builders risk insurance for this work as the professional covers it for their work and your home policy will have some basic cover for the work
• Any electrical certificates, warranties provided – the bank wont generally need these but its good for you to retain them
• Banks again will run a 15% overrun allowance, this is generous it probably should be 25% to 40% on some projects like bathrooms and kitchens!

Products for these types of loans

We have some banks provided discounted products through the build phase,

ASB 1.25% off the floating rate for up to two years as well as a cash contribution typically up to 90% of the loan amount. ASB standard floating rate is 6.29% so 5.04%.

ANZ  Blueprint to build1.25% off the floating rate for two years and 0.60bps off standard fixed rates post full drawdown. Today that’s 4.65% versus the ANZ special of 4.75% fixed for 1 year and 5.04% floating versus a standard floating rate of 6.29%. A cash contribution is also available typically 0.90% of the loan amount.

For the energy efficient work point 4 under non consented or cosmetic renovations most main banks are providing 1% fixed for three years up $80k and one provider is 0% for 5 years fixed up to $50k.