Construction Loans: What Not to Do with Extensions

A construction loan for an extension works differently to a standard home loan.

When you borrow for an extension, the lender releases funds progressively as the build reaches key milestones. You only pay interest on the amount drawn down, not the full approved loan amount. Most lenders require council approval, a fixed price building contract with a registered builder, and a progress payment schedule before they'll approve the application. The structure can feel unfamiliar if you've only dealt with traditional home loans before.

How Progressive Drawdown Works for Extensions

The lender holds your approved loan amount in reserve and releases it in stages, typically after a progress inspection confirms each phase is complete. For an extension in Burwood, a typical schedule might include five draws: base stage, frame stage, lockup, fixing, and completion. At each stage, the lender or an independent valuer inspects the site, verifies the work matches the stage description, and releases the corresponding payment to the builder.

You only pay interest on the amount drawn down. If your approved loan is $200,000 but only $50,000 has been released at base stage, your interest charges apply to $50,000, not the full loan amount. This reduces your repayments during construction, but it also means your repayments increase each time another draw occurs. Many borrowers forget to budget for the rising repayment schedule as the loan balance grows.

Lenders also charge a progressive drawing fee for each inspection and drawdown, typically between $300 and $500 per draw. Across five draws, this adds $1,500 to $2,500 to your total project cost. Some lenders waive or reduce this fee depending on the loan size or if you're refinancing other debt to them at the same time.

Council Approval Before You Apply

A lender will not process a construction loan application until you have council approval for the extension. This is not the same as a development application lodged and awaiting assessment. The approval must be issued, and any conditions must be clear. If you apply for construction finance before this step is complete, your application will sit idle or be declined outright.

In Burwood, council turnaround times can vary depending on the complexity of the extension and whether it triggers heritage or neighbourhood character overlays. If your property is near Burwood Village or within one of the older residential pockets close to Burwood Highway, expect additional scrutiny and potentially longer approval periods. Start the council process months before you plan to draw the first payment.

Fixed Price Contracts and Cost Plus Arrangements

Most lenders will only approve construction finance against a fixed price building contract. This means the builder provides a total contract price, and that figure forms the basis of the loan amount. The lender knows what they're funding, and you know what the build will cost, assuming no variations.

Cost plus contracts, where the builder charges for materials and labour plus a margin, are harder to finance. The final cost is uncertain, and lenders view this as higher risk. Some specialist lenders will consider cost plus arrangements, but they typically require a larger deposit, charge higher rates, and impose stricter drawdown conditions. If your builder is proposing a cost plus contract, clarify this with your mortgage broker before signing. Switching contract structures midway through an application is disruptive and can delay your start date.

The Start Date Clause You Must Understand

Most construction loan approvals require you to commence building within a set period from the disclosure date, typically six months. If you don't start within that window, the approval lapses, and you'll need to reapply. Market conditions, your financial position, and the lender's appetite may have shifted by then, which can result in a lower approved amount or a declined application.

Consider a buyer who secured construction finance approval in winter but didn't finalise the builder contract until the following spring. By the time they were ready to draw down, the original approval had expired. Interest rates had risen in the interim, and the lender recalculated serviceability at the higher rate. The buyer's approved loan amount dropped by $30,000, forcing them to reduce the scope of the extension or find additional cash. The delay cost them both time and money.

What Happens If the Build Runs Over Budget

If your builder requests a variation or the project runs over budget, the lender will not automatically increase your approved loan amount. You'll need to apply for a top-up, which involves a fresh credit assessment, updated valuation, and additional approval time. If your financial circumstances have changed since the original approval, or if property values in Burwood have softened, the top-up may not be approved.

This is one reason why padding your loan amount slightly above the contract price can provide a buffer. However, lenders will only approve additional funds if the valuation supports it. If your property is currently valued at the lower end of Burwood's median range, particularly in areas further from Deakin University or the train station, your equity buffer may be tight, and there may be no room for cost overruns.

Interest-Only Repayments During Construction

Most construction loans default to interest-only repayments during the construction period. Once the build is complete and you draw the final payment, the loan converts to principal and interest repayments, unless you negotiate otherwise. For a borrower extending their home in Burwood, this means lower repayments for six to twelve months while the work is underway, followed by a sharp increase once the loan converts.

If you're living in the property during the extension, you're still covering your existing mortgage or rent equivalent, plus interest on the construction loan as it grows. The combined repayment load can strain cash flow, particularly if one income earner has reduced hours or if childcare costs are high. Run the numbers for each drawdown stage before you commit to the project. You can explore how different loan structures affect repayments using construction loan options tailored to your situation.

Owner Builder Finance and Why It's Difficult

If you're planning to act as an owner builder for your Burwood extension, expect financing to be more difficult. Most mainstream lenders will not provide owner builder finance due to the higher risk of project delays, cost blowouts, and incomplete work. The lenders that do offer it typically require a minimum 20% deposit, charge higher interest rates, and impose strict conditions around progress inspections and drawdown timing.

Owner builders also need to manage subcontractors, coordinate trades, and ensure compliance with building codes and council conditions. If you underestimate the time or cost involved, the project can stall, and the lender may refuse further drawdowns until issues are resolved. Unless you have significant construction experience and a strong cash buffer, owner builder finance for an extension is a high-risk path.

Choosing the Right Construction Finance Structure

You have a choice between a construction-only loan and a construction to permanent loan. A construction-only loan covers the build period, and you refinance to a standard home loan once the project is complete. A construction to permanent loan rolls the construction phase and the ongoing mortgage into a single approval, which means one application, one set of fees, and no need to refinance at the end.

For most Burwood homeowners extending their property, a construction to permanent loan is the simpler option. It locks in your interest rate structure for the life of the loan, not just the construction phase, and removes the risk of having to requalify for finance after the build. If you're refinancing an existing mortgage at the same time, consolidating everything into one loan with one lender can also reduce complexity and ongoing fees. You can assess whether refinancing makes sense alongside your construction project by reviewing refinancing options that align with your goals.

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