Smart ways to approach knockdown rebuild finance

A knockdown rebuild means you're borrowing against land you already own or are buying, demolishing what's there, and building from scratch.

The structure of a construction loan is different to a standard home loan because the property you're securing it against doesn't exist yet. Lenders release funds progressively as the build reaches specific stages, and you typically pay interest only on the amount drawn down. That progressive release means you're not paying interest on the full loan amount while the slab is being poured or the frame is going up. It also means the lender wants to see council approval, fixed price building contracts, and a registered builder before they'll commit.

If you already own the land, the equity in that block can work as part of your deposit. If you're buying the land and building straight after, the lender treats it as a land and construction package. Either way, the approval process takes longer than a standard home loan because the lender is assessing both your financial position and the viability of the build.

How lenders release funds during the build

Most lenders release construction funds in five or six stages tied to physical progress on site. These are called progress payments, and they're triggered by an inspection from the lender's valuer or building consultant. Common stages include base stage (slab or stumps), frame stage, lock-up stage (roof and external walls), fixing stage (internal fit-out), and practical completion. The builder invoices you at each stage, you request a drawdown from the lender, the lender inspects, and then the funds are released.

You don't control the timing of these drawdowns. The builder does. That means if there's a delay between frame and lock-up, you're still paying interest on whatever's been drawn so far, but the next portion of the loan sits untouched. Some lenders charge a Progressive Drawing Fee each time funds are released, usually between $300 and $500 per draw. That can add up across a six-stage build, so it's worth confirming upfront what the total fee structure looks like.

The progress payment schedule in your building contract should match the drawdown stages in your loan. If the builder wants 30% upfront and the lender will only release 15% at base stage, you'll need to cover that gap from your own funds. We regularly see this with custom builders who operate on cost plus contracts rather than fixed price arrangements.

Interest charges before the build is finished

You start paying interest as soon as the first drawdown happens. That might be months before you move in. If the lender releases $150,000 at base stage and the variable rate is sitting at 6.5%, you're paying roughly $810 a month in interest on that portion alone. By the time you're at lock-up and $400,000 has been drawn, that monthly interest bill is closer to $2,160.

Most construction loans default to interest-only repayments during the build, which keeps your monthly outgoings lower while you're still paying rent or living elsewhere. Once the build reaches practical completion and the final drawdown happens, the loan converts to a standard home loan with principal and interest repayments unless you arrange otherwise. That conversion usually happens automatically, but it's worth confirming what rate and loan type you'll roll onto before you sign anything.

Some lenders allow you to make additional payments during construction if you want to reduce the loan balance before it converts. Others don't. If you're expecting a tax return, bonus, or sale proceeds from another property during the build, check whether your loan structure allows for those payments without penalty.

What lenders want to see before they approve a knockdown rebuild

Lenders need proof that the project is planned, costed, and approved. That means a fixed price building contract with a registered builder, council approval or at least a development application that's well progressed, and detailed plans showing what's being built. The contract needs to include a clear progress payment schedule and a build timeframe. Most lenders also require you to commence building within six to twelve months from the loan's disclosure date. If you delay beyond that window, you may need to reapply.

If you're using owner builder finance, the approval process is more involved. Lenders treat owner builders as higher risk because there's no registered builder providing warranty insurance, and the project relies entirely on your ability to coordinate trades and manage costs. You'll typically need a larger deposit, a more detailed cost breakdown, and signed quotes from plumbers, electricians, and other sub-contractors before the lender will proceed.

Consider a buyer who owns a 1960s weatherboard cottage in Mount Hawthorn on a 700-square-metre block. The land is worth $750,000, and the existing structure adds little value. They want to knock it down and build a two-storey, four-bedroom home for $550,000. Their total project cost is $1.3 million. They're using the $750,000 land equity as the deposit, borrowing $550,000 for the build, and keeping $50,000 in cash for demolition, council fees, and any cost overruns. The lender assesses their income and confirms they can service the full $550,000 loan, approves the contract with the builder, and structures the loan to release in five stages. Interest starts accruing once demolition is finished and the first stage payment is drawn.

Choosing between variable and fixed rates for construction loans

Construction loans almost always start on a variable rate during the build because lenders need flexibility around drawdowns and inspection timing. Once the build is complete and the loan converts, you can usually split or fix part of the balance if you want rate certainty going forward. Some lenders offer a discounted construction loan interest rate during the build, then move you to their standard variable rate at completion. Others keep you on the same rate throughout.

If you're planning to refinance after the build is finished, it's worth holding off on fixing until that's done. Break costs on fixed rate loans can be significant if rates have moved, and refinancing during construction is rarely practical because most lenders won't touch an incomplete build.

How demolition and site costs fit into the loan

Demolition usually happens before the first construction drawdown, which means you'll need to fund it separately unless the lender agrees to include it in the initial advance. Some lenders will release funds to cover demolition and site prep as part of the first stage if it's itemised in the building contract. Others won't. If you're paying for demolition out of your own pocket, expect between $15,000 and $30,000 depending on the size of the existing structure, asbestos removal, and whether the block needs retaining or earthworks before the slab goes down.

Council fees, engineer reports, soil tests, and other pre-construction costs also sit outside the standard progress payment schedule. Those can add another $10,000 to $20,000 depending on the site and local council requirements. If your budget is tight, make sure you've accounted for these upfront costs before the building loan is drawn.

Loan amount and borrowing capacity for knockdown rebuilds

Lenders assess your borrowing capacity based on your ability to service the full loan amount once construction is complete, not just the interest-only payments during the build. That means they're looking at what your repayments will be when the loan converts to principal and interest on a standard 30-year term. If you're currently renting and plan to move into the new build, they'll factor in that you'll no longer have rent to pay. If you're holding another property, they'll include that mortgage in their assessment.

Your deposit requirement depends on whether you already own the land. If you do, the equity in that land counts toward your deposit. If you're buying the land and building straight after, you'll need a deposit that covers at least 20% of the combined land and build cost to avoid lenders mortgage insurance. For a $1.2 million project, that's $240,000. If you're using equity from another property instead of cash, the lender will assess that equity as part of the overall security.

What happens if the build runs over time or over budget

If the builder is delayed and the project drags on, you're paying interest on drawn funds for longer than expected. That's manageable if the delay is a few weeks, less so if it's months. If the project goes over budget and you've exhausted your loan amount, you'll need to cover the shortfall from your own funds or apply for a top-up. Lenders don't automatically increase the loan mid-build. You'll need to reapply, provide updated financials, and hope your income still supports the higher amount.

Fixed price building contracts with a registered builder reduce this risk because the builder is locked into the agreed price. Cost plus contracts shift more of the risk to you, and lenders know that. If you're going down the cost plus route, expect the lender to scrutinise your budget more closely and potentially hold back a larger contingency before they approve the final drawdown.

Call one of our team or book an appointment at a time that works for you. We'll talk through your situation, confirm what you'll need for the application, and help you line up a loan structure that matches the way your build will actually unfold.

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