How a construction loan works
Construction loans differ from standard mortgages in two important ways. First: the lender doesn't release the full loan amount up front. Instead, the loan is paid out in 'progress payments' to the builder as construction reaches predetermined stages — typically 5 stages following the HIA / MBA standard schedule: deposit/slab, frame, lock-up, fixing, completion. Second: you pay interest only on the cumulative amount that's actually been drawn — meaningfully less than full-loan interest during the early months of construction.
The standard cumulative draw percentages are: slab 15%, frame 30%, lock-up 50%, fixing 80%, completion 100%. The exact split varies a little between lenders and builders. Most construction loans charge interest-only during the build phase, with the loan converting to a standard P&I (or interest-only) mortgage when the certificate of occupancy is issued. Construction-specific rates run 0.3-0.7% higher than standard variable rates because the lender's exposure is uncollateralised until the house is complete.
The biggest risks during construction: builder failure (especially in the post-COVID environment with many high-profile collapses), cost overruns requiring loan top-ups (often at higher rates), and delays that extend the construction period and add interest. Most lenders allow some flexibility on the construction period (typically 12-24 months) but charge default rates if you blow the timeline. For total mortgage cost over the full loan life, see our Mortgage Repayment Calculator.