Construction vs Land and Build (Turn Key) Loans
Which loan is right for you?
In recent years there have been changes to the way you can build a new home, rental property, or lifestyle property. The traditional way of building is a thing of the past. No longer is there a need for a valuer to come out and evaluate the progress of your build at each draw downstage – the future is here and there are two main options:
- Construction Loans
- Land and Build Packages (also referred to as Turn Key)
Construction loans are considered the more traditional way of building, and overall can be the cheapest method. However, there is a substantial amount of work to do to build a home using a construction loan.
Construction loans generally mean you go out and find the section you would like to build on. Then you purchase the section and then look around at what different building companies are offering in the way of plans and building designs. Once you have settled on the style and plans of a house with a builder, you will more often than not need to arrange finance.
This is where Construction Loans are a little more challenging than the newer ‘Land and Build Packages’ (sometimes referred to as Turn-key Builds). When building via a construction loan the lenders will ask for extra information above and beyond a normal application of finance.
Things the lender will require:
- A full statement of position (application form)
- A Sales and Purchase document
- A registered valuation of the project
- Full set of plans/specifications
- Building permit/consent
- Builder’s Risk Insurance
Using a mortgage broker is a good idea if going this route as there are large differences in what each lender in New Zealand offer when it comes to their build policies. Banks policy vary hugely in what they offer and there is a big difference between the best and worst options.
Typical Progress with a Construction Loan:
A lender will require a Fixed Price Contract from the builder with a drawdown schedule published within the contract. The drawdown schedule provides evidence to the lender on how the build will be paid for through the build process.
Consents and permits from council for the build will need to be provided to show what you intend on building has been approved by council. In most cases, your builder will do this for you.
Your builder will have to provide evidence that Builder’s Risk Insurance is in place for the build. This provides protection against damage during the build process, so if something is damaged and has to be replaced you or the bank are not out of pocket because the Builder’s Risk Insurance covers the cost of the damage.
A Registered Valuation is required before the build starts. The lender wishes to understand the value of the build before it starts (the value of the land), typically known as the ‘as is’ value and the ‘as completed’ value, which is the combined value of the land and the build once the build is finished.
Outside of these points, the rest of an application for finance is unchanged from what is supplied as part of an application to purchase an existing or pre-loved house.
Once the build starts and the progress payments begin (mentioned in the drawdown schedule) so does your obligation to pay the mortgage. At the start, the repayments will be small because the payments for the build have only just started. For example, the first payment is usually required once the floor slab has been laid, then another when the walls are up and the roof is on, and so on until the build is completed.
The final payment is only released by the lender when the Code of Compliance from Council is issued and the house is ready for you to move in.
Land and Build Packages (Turn Key Builds)
Land and Build packages have become more popular recently and although they are often a little more expensive than a construction loan. They have what some would argue are some significant advantages over a construction loan.
When you build and use a Land and Build Package the process is considerably different from building and using a construction loan. Depending on the builder, there is normally a small deposit required upfront before the build starts. Then no further funds are required until the build ends.
Things the builder will require:
- A signed Sales and Purchase document
- Evidence that finance to purchase the property has been completed
- A 10% deposit as a sign of goodwill
Unlike the fixed price contract there are no drawdown payments required by the builder. Hence consents and permits are not required by the lender. The purchaser is removed from any disagreements between what the lender and expects it to be built at every drawdown stage and what the builder has completed. The process is also a lot less complicated as the builder completes most of the steps required to build the property, unlike a construction loan.
Typical progress with a Land and Build Package
All the costs of the build are paid by the builder as the build is completed. There is no need to supply a Fixed Price Contract to the lender. The Consent and Permits are still required. Nonetheless this is completed by the builder as it is a need to provide Builder’s Risk Insurance.
Outside of the normal lending criteria to purchase any house when lending is required, the only condition required when building vis a Land and Build package is to have a registered valuation completed to illustrate the value of the house once the build is completed.
The Advantages and Disadvantages of these building loans
These are two distinct ways of building a new home. There is nothing wrong with either option; however, there are some advantages and disadvantages to consider.
Advantages of a Construction Loan
- Engage any builder you’d like to build your home
- Less expensive than Land and Build overall
Advantages of a Land and Build Package
- Only a small deposit, around 10%, is required to start the build
- No mortgage repayments during the build
- Less conditions to be met when applying for lending
- Mortgage repayments only start after Code of Compliance is received and you have moved into the property.
Disadvantages of a Construction Loan
- Higher deposit, around 20%, to get started
- More work to be completed by the applicants
- Mortgage repayments need to be made during the build process
Disadvantages of Land and Build
- The builder already has an interest in the land, so if a section is ‘liked’, then the applicants need to use the builder that has the interest in the land.
- Little more expensive than a construction loan
The Third Method: Labour Only Contract
When you employ a builder to work for you on a labour-only contract you manage the whole process. The builder is only responsible for the building of your property. People often take this option in the belief that they will have better control over the building process or because they want to save money. Many times a labour-only contract is used because the vendor has contacts within the building industry. Hence they believe they can knit together a build using these contacts, resulting in a cheaper build.
With this type of contract, you either pay your builder by the hour, by the week, or a set price set out before the build starts. Many like paying a set price as it incentivises the builder to work steadily to finish the job in a reasonable time frame. This is because the job would have been priced on a set number of hours. This can be affected by outside influences such as weather or the availability of materials.
Some drawbacks of the Labour-Only contract
- As the project manager, you become the main contractor which means you are responsible for the work meeting Building Code. Also for any defects in the construction process.
- The responsibility for coordinating all the different facets of the build rests with you. This means making sure everything happens as and when it should and that the timing of different tradesman, materials, and equipment relies on your project management skills. It will take a huge amount of your time and energy to hire contractors, buy materials and manage the project. Hence at times it could be inconvenient to you, your family and if you are working at the same time, your employer.
- You are responsible for health and safety on the building site. This has become tougher recently with the introduction of the new health and safety rules.
For everyone’s protection, make sure the duties of each party are very clearly spelled out in the building contract, allowing each person to know what they are doing and their responsibilities while onsite.
Managed Labour-Only Contract
Another option to a labour-only contract is the managed labour-only contract. This type of contract is partway between a full fixed-price contract and a labour-only contract. Under this arrangement, the builder manages the day-to-day building of the property. The builder is responsible for pricing the job, receiving quotes, and organising the materials and subcontractors to complete different parts of the build.
However, the builder may do some of this work depending on what you’ve agreed in the contract. People looking to build usually choose this option to save money by doing some of the work themselves. However, this can be a huge time commitment and does usually require some previous experience in project management.
You won’t always save by purchasing the materials yourself, this is because even though builders add a mark-up to the materials they supply, they buy these materials at trade prices so they will often still be cheaper than what you can buy over the counter. However, if you are buying a house load of materials you could negotiate a substantial discount with the supplier or suppliers.
Warning - If you buy the materials yourself, any problems with quality or quantities will be your responsibility to sort out. This, of course, is the builder’s problem when completing a build through either a Fixed Price Contract or Land and Build Package.
If you choose a Managed Labour Only Contract, you need to be satisfied that the communication between you and the builder and lines of responsibility are very clearly defined within the contract.
Making it clear on what kind of contract you want
It is absolutely crucial that you and your builder are very aware of what sort of contract you want, this is particularly important with builds because there is such a huge difference in the expectations from one type of contract to another.
Most builders will fit in with the type of service you ask for but you’ll probably find that most have a preference. Some builders may prefer not to work under anything but a full fixed-price contract or turn-key so they can keep control over the project.
Just make sure you are sure and happy before you sign anything.
Discover which loan option is best for your build
There is no right or wrong way to complete your build. There are, however, options available to you to complete the construction process. When people who are busy and have not built before then maybe the turn-key option is better suited. Furthermore, if you are experienced and don’t mind the challenges of completing a fixed price contact build then the option is available.
At Advanced Mortgage Solutions, we pride ourselves on taking our clients through the whole process from start to finish. We will happily help you through whichever option you wish to take.
Please contact us to learn more about building the perfect property.
Published by Scott Miller
Today's announcement on Mortgage Holidays
With today’s announcement by the Finance Minister about 6-month mortgage holidays, we have been inundated by enquiries from our clients.
Awesome. We couldn't be more thrilled with our experience and have nothing but high praise for Scott Miller and AMS.Simon Thrupp and Sandra Paterson - 14 August 2018
A huge thanks to Scott for his knowledge, advice and professionalism through our entire first home buying experience.Jamie Hetherington and Michelle Roundhill - 01 December 2016
Scott was always friendly and professional, and seems very knowledgeable about all the different lending institutions.John and Anna Sinclair - 05 May 2016