What the arrangement is
When you build, the lender does not hand over the whole loan on day one. It is released in stages as the builder finishes each part of the house. We explain that in how a construction loan draws down. Normally you pay interest on whatever has been drawn so far, starting from the first draw. For most of a year you are covering the costs of where you live now as well as a growing interest bill on a house that nobody can live in or lease yet.
A repayment pause changes the timing. Under this kind of arrangement, which some lenders offer, you make no repayments during construction for up to twelve months. Interest still accrues every day on the amount drawn. Instead of being paid month by month it is added to the loan balance. That is called capitalising the interest.
What it costs, with the arithmetic shown
The clearest way to see it is as a trade: more cash in hand now, in exchange for a larger loan later. Here is an illustration with round numbers. It is not a quote, and your own figures will differ.
- Land of $300,000 settles at the start, so that amount is drawn for the full twelve months.
- A build of $350,000 is drawn in stages across the year, so on average roughly half of it, about $175,000, is outstanding.
- At an illustrative interest rate of 6.5% a year, the interest on the land is about $19,500 and the interest on the build is about $11,400.
In this example about $30,900 of interest is added to the loan across the year. You did not pay it during the build. You owe it afterwards, and you pay interest on it for as long as it stays in the balance. At the same illustrative rate, that extra $30,900 costs roughly $2,000 a year in interest until it is paid down.
Two things move the number: the interest rate, and how quickly the loan is drawn. A build that runs to schedule reduces it. A slow build, or land that settles many months before the slab is poured, increases it.
Who it tends to suit
- Investors whose borrowing capacity is fine but whose monthly cash flow would be stretched by carrying two sets of costs for a year.
- People who want to keep a cash buffer intact during the build instead of spending it on interest.
- People who have seen the repayment that applies after the pause, in writing, and are comfortable with it.
Who it does not suit
- Anyone who can comfortably pay the construction interest as it falls due. Paying as you go costs less overall.
- Anyone relying on the pause because the loan would otherwise be unaffordable. Repayments still begin, and they begin on a larger balance.
- Anyone who has not been shown what the balance and the repayment will be on the day the pause ends.
Questions to ask before you agree to one
- What will the loan balance be on the day repayments start, and what will the repayment be?
- Is the interest rate during the pause the same as the rate afterwards?
- What happens if the build takes longer than twelve months?
- Are there fees for the arrangement, and are they added to the loan as well?
- Does the pause change the loan term or the type of repayment afterwards?
Who decides
The lender does. Eligibility, the maximum length of the pause and the terms all vary between lenders, and not every lender offers one. Citadel Developments is not a lender and does not hold an Australian Credit Licence, so we do not assess you for it and we do not recommend it. What we do is raise the question early, so that a licensed broker can tell you whether it is available to you and what it would cost in your case before you commit to land.