A construction loan pays your builder in stages, and most lenders charge interest only on the money released so far, though this varies by lender. Understanding that one feature makes the rest of the loan structure much easier to follow.
This guide is for anyone planning a granny flat or new home who wants to know how the loan will actually work before they sign a building contract. We arrange construction loans for granny flats with lenders across Australia, so these are questions we hear every week.
How Does a Construction Loan Work?
A construction loan releases your approved loan amount to the builder in stages as work is completed, rather than as one lump sum at settlement. This is often called progressive drawdown.
The lender approves a total limit based on your contract, plans and its own policy. Money then goes out at set points, such as base, frame, lock-up, fixing and completion. Before each payment, the lender usually asks for a progress inspection or an invoice from the builder. Each lender sets its own number of drawdowns, inspection rules and fees, so check these before you choose.
Where interest is charged only on the amount drawn, early repayments are small and rise as the build moves along. Confirm with your lender how interest is charged and when repayments start, and check for fees. The trade-off is that your repayments grow with each stage, so you need to plan for the higher amounts at the end.
What Is a Construction Draw Schedule?
A construction draw schedule is the list of stages at which the lender releases money to your builder, and the amount released at each one. It is set out in your building contract.
The rules on payments differ by state. In NSW, a contract over $20,000 needs a progress payment schedule, and payments must match the work actually carried out. In Queensland, a builder cannot claim more than 50 per cent of the contract price until at least half the on-site work is done. In the Northern Territory, a standard schedule is set out for residential contracts. Deposit limits also vary by state, for example 5 per cent in Queensland for contracts of $20,000 or more, and 10 per cent at most in NSW. Check the rules for your state with your state's building regulator before you sign.
If a builder asks for payments ahead of completed work, raise it with your broker and the regulator early. Paying early can reduce the protection that home warranty insurance gives you.
Fixed Price Contracts vs Cost Plus Contracts
A fixed price building contract sets the total cost up front, while a cost plus contract charges the actual cost of the build plus a margin. Some lenders may prefer fixed price contracts because the total is known.
With cost plus, the final figure can move as materials and labour costs change. That can suit a custom design where the details are still being worked out, but it carries the risk of the build costing more than you planned. Some lenders may want a larger buffer or a detailed budget in that case. If you choose cost plus, ask your builder for a clear estimate and talk to us about it before applying.
Interest-Only Repayments During the Build
Whether interest-only repayments are available during construction depends on the lender and the product, so confirm the terms with your lender. NSW Government guidance says a borrower financing a project home must start repayments once the first progress payment is made and they begin to draw down.
When the build finishes, the loan normally moves to principal and interest over the remaining term. Interest-only repayments keep early costs lower, but they do not reduce what you owe, and the later repayments are higher because the principal must be repaid over a shorter period. Our page on interest-only construction loans explains how this works for investors.
As an illustration only, at an example rate of 6.75% p.a. a $300,000 loan costs about $1,688 a month in interest alone ($300,000 x 6.75% / 12). That figure applies once the full amount is drawn. If interest is charged only on the amount drawn, repayments during the build are lower because less is drawn. Use our mortgage repayment calculator to test your own numbers.
Example: Staged Payments on a Granny Flat Build
Consider a homeowner who wants to build a granny flat for a parent, using the equity in their existing home. The total build is $300,000 under a fixed price contract, and the borrower wants to keep repayments manageable during construction.
The broker structures a construction loan secured against the existing property, with the contract split into five stages. At the example rate of 6.75% p.a., a first payment of $30,000 for the deposit and site works adds roughly $169 a month in interest ($30,000 x 6.75% / 12). By the time $150,000 has been drawn at frame stage, interest is about $844 a month. At completion, with the full $300,000 drawn, interest is about $1,688 a month. These figures are illustrative and exclude fees.
The outcome is that the borrower's costs build up gradually and the lender releases money only after each inspection. Once the build is complete, the loan converts to principal and interest. Using home equity to build a granny flat often works well for this reason, though it does put your existing home up as security.
Construction to Permanent Loan: What Happens at Completion?
A construction to permanent loan converts to a standard home loan once the build is finished and the lender has confirmed completion. Repayments then switch to principal and interest, or to interest-only if your lender and loan type allow it.
Some borrowers use a split loan so part of the balance is fixed and part stays variable. The trade-off is that a fixed portion may carry break costs if you repay it early. Lenders will also assess your ability to repay at a rate well above the loan rate. APRA confirmed the buffer at 3 percentage points above the loan rate as at its May 2026 update, so approval depends on your income and debts, not only on the project.
What Do Lenders Look For in a Construction Loan Application?
Requirements vary by lender. Lenders commonly ask for a licensed or registered builder, a contract, plans and approvals, along with enough income to service the debt. Confirm your lender's requirements before you sign a building contract.
The lender will also arrange a valuation, which may be on an "as if complete" basis. The amount you are approved for depends on the lender's policy, and valuations can be conservative. You can get a feel for your position with our borrowing capacity tool. Tax can be complicated for investment builds, so speak with your accountant about deductions and holding costs.
Our team can compare construction loan options from banks and lenders across Australia and match the structure to your build. Call one of our team or book an appointment at a time that works for you using our booking page.
Frequently Asked Questions
How does a construction loan work?
A construction loan releases money to your builder in stages as work is completed. Most lenders charge interest only on the amount drawn so far, so repayments rise as the build progresses, but this varies by lender. Confirm how interest is charged, when repayments start and what fees apply.
What is a construction draw schedule?
It is the list of build stages at which the lender pays the builder, and the amount paid at each one. It is set out in your building contract and the rules vary by state.
Can I make interest-only repayments during construction?
It depends on the lender and the product. Confirm the terms with your lender. The loan usually moves to principal and interest after completion.
What is the difference between fixed price and cost plus contracts?
A fixed price contract sets the total cost up front. A cost plus contract charges the actual build cost plus a margin, so the final figure can change and carries more risk of overspending.
