How to Finance Your Knockdown-Rebuild

by Carlisle Homes

So, you’ve decided to embark on a knockdown-rebuild so you can get the modern, energy-efficient home of your dreams and stay in the neighbourhood you love. But how do you finance it? Carlisle’s in-house financing expert reveals all.

A knockdown-rebuild gives you the best of both worlds – create a beautiful contemporary home that fits your family’s needs to a tee, while staying put in the area where friends are close by, the kids are settled in school, and you’ve built your life. Not to mention saving you on stamp duty by buying elsewhere.

Carlisle Homes is Melbourne’s knockdown-rebuild specialist and have beautiful home designs specially tailored to suit these projects. If you’ve decided to embark on a knockdown-rebuild and have questions around how to finance it or whether you need a special type of home loan, Mark Polatkesen, Director and Senior Mortgage Broker at Mortage Domayne, Carlisle Homes’ in-house financial specialists, has the answers.

What type of home loan do you need?

“Most people choose a construction loan for knockdown-rebuilds as these allow you to draw funds in stages that sync with the payment instalment dates for your new build. For example, at the signing of the building contract, when your builder lays the concrete slab, at the end of the framing stage, and when your home is completed.

“This saves you money, as you only pay interest on the progress payments made until the loan is fully drawn.

“Be aware that most banks and lenders need you to have a building contract signed with a licensed builder before you can apply for a construction loan,” says Polatkesen.

How are you assessed for a construction loan?

“Lenders will use loan-to-value ratio (LVR) combined with an income test to work out how much you can borrow,” says Polatkesen. LVR is the percentage of the loan amount compared to your property’s value. Typically, lenders are comfortable with an LVR of up to 80 percent, meaning you’ll need at least 20 percent deposit. But if you have enough equity in your current property, you may not need any deposit.

“For a knockdown-rebuild, lenders will look at the value of your land plus the new, completed property. So, if your current property is worth $1.1 million, but $100k of that is the house that is being demolished, they will put the land value at $1 million. If you have a $500k building contract for the new house, they will then add that to the final value, putting it at $1.5 million. Assuming you don’t have a mortgage, they may then lend you $500k against that $1.5 million value,” he says.

How much deposit do you need for a construction loan?

“We have lenders who will lend up to 95 percent of a construction loan, meaning you might need as little as five percent. And if you have built up enough equity in your current home, you may not need a deposit at all,” says Polatkesen. “This means the bank will lend you one hundred percent of the construction value, based on your existing amount of equity.

“Builders typically require some form of deposit when you sign your building contract – this is generally around five percent. If that’s the case for you and you’d prefer to retain as much of your savings or deposit as possible and only use equity, we can often get that money reimbursed to you at a later point in time,” he says.

Can you get a loan if you have a mortgage?

“Yes, provided you have enough equity, you can continue to work with your current home loan, and just add the construction portion on top of that,” says Polatkesen. “You may also choose to use your savings as a partial contribution towards the rebuild, or use a combination of equity and savings.”

“Another option is to refinance your existing mortgage. This involves renegotiating a new loan with your current lender, often at a lower interest rate, and incorporating the cost of your rebuild into the new loan amount,” he says.

Can you use a home equity loan?

“Yes, you can,” says Polatkesen. “If you’ve lived in your current property for a long time and have built up significant equity, you can apply for an equity loan to finance your knockdown-rebuild. This involves borrowing against the value of your existing property to fund your new build. If you have enough equity in your current property, you may find it’s enough to fund the entire rebuild project, including demolition, fencing, landscaping and even furniture.

“One important thing to remember: when assessing how much equity you have in your property, you can’t include the house value in its current form as it won’t exist after demolition.

“With a knockdown-rebuild, when assessing how much equity you have in your home, the bank or lender will work on your site value plus the value of the new construction – in other words, your building contract with its plans and specifications, which is the capital that will improve the value of your property.

“Also, if you choose a home equity loan, be aware that interest rates will kick in immediately,” says Polatkesen.

What’s good to know about valuations?

“It’s worth noting that property valuations can vary between lenders,” says Polatkesen. “This is particularly true in established areas where you’re putting in a brand-new home, and don’t have any recent sales to compare it to. Without enough data available, lenders may simply end up comparing your property to one that’s 10 or even 20 years old – and as we know, the older a house gets, the more it depreciates in value.

“If you’re not getting the valuation you want or need, it’s worth getting another valuation done before putting in your loan application, which is something a mortgage broker can arrange for you. At Mortgage Domayne, we’ve seen variations of up to $250k on the same property, which is very significant,” he says.