What are Split Contracts – Home Construction Loans

What are Split Contracts – Home Construction Loans

If you have ever sought to build your own home or investment property, or purchased a house and land package, you may be familiar with the construction loan requirements many lenders impose on borrowers. You may also be familiar with how lenders pay your builder i.e. via a progress payment schedule usually split into five stages as follows:

  1. Slab (including deposit) – 15%
  2. Frame – 15%
  3. Lock-up – 35%
  4. Fixing – 25%
  5. Practical Completion – 10%

However, there is a little known area that borrowers should be aware of that may adversely affect a construction loan application and may mean that you don’t qualify for the above traditional construction loan with progress payments; Split Contracts.

What is a Split Contract?

A split contract usually relates to a multi-unit development that is two or more dwellings on one site.

Generally speaking, split contracts may have the following key features:

  • Communal areas;
  • Shared or parapet walls;
  • Shared footings;
  • Same builder across all properties;
  • Group planning approvals where multiple buildings are interdependent;
  • Unit, Strata or Survey Strata title;
  • No split of value for land/improvements; and
  • Very small lots, where maximising the potential of the block means relying on the other people in the development.

The key here is that the construction of one dwelling may be reliant upon or interdependent with the construction/completion of another dwelling within the same development.

For a lender, this is a crucial matter because they need to be sure that if they finance you to purchase land and construct a dwelling upon that land, that the construction of your dwelling is not going to be affected if the neighbouring properties’ construction was to be held up. An example of how this can happen is if the purchaser of the neighbouring/adjoining property ran out of money and could not complete their construction. In this case, it may mean that because your neighbour cannot afford to continue the construction of their dwelling, which may have an adjoining wall and/or footings with yours, that then you would not be able to complete the construction of your dwelling.

Many lenders see this as a substantial risk and prefer not to finance such contracts on a progressively drawn basis, which means that they may not finance the construction component at all and therefore means they will only consider such packages as an “Off the Plan” purchase.

This then raises the question as to who will fund the construction? In the above case (i.e. where a ‘split contract’ has been identified) this will become the developer’s responsibility and they will need to fund the construction of all dwellings subject to the split contract arrangement.

Lenders will generally look to the valuation for confirmation that the contract is not a split contract. However, even if the valuer doesn’t specifically note that the property is a split contract, lenders may still check the characteristics and features of the building plans/contract to ensure it is not a split contract.

What is an Off the Plan Purchase?

Off the plan purchases can be described as a ‘buy now pay later’ method of acquiring property, which enables the prospective purchaser to purchase a property that has not yet been built.

Purchasers generally exchange contracts for a property from the description in the developer’s plans. Buyers are typically required to pay up to a 10% deposit (although sometimes a lower deposit may be negotiated) upon exchange of contracts with the balance to be paid upon completion of the property which can take up to 18 months (depending on the construction program indicated within the contracts).

Once the construction is mostly completed, the lender will then require the valuation to be instructed. The valuer will then come back to the lender with their sworn valuation and if this upholds the contract of sale price, then the lender will only need to fund the purchase of the completed dwelling rather than funding the land purchase and construction.

This type of purchasing arrangement is quite common for apartments and/or houses in new housing estate developments.

Given the often long lead-time between signing a contract and construction completion in Off the Plan purchases, it should be noted that in some instances, Off the Plan contract prices may not always result in a sworn valuation of the same amount. We have seen clients have to come up with more funds from their own resources because the valuation came in lower than the contract price, and this is not uncommon.

This is important to note because there is the potential that the shortfall may be quite significant. For example, if you purchased a property for $750,000 and the valuation came in 10% less, this may mean that you may need to come up with a further $75,000 from your own savings, or pay Lenders Mortgage Insurance (LMI) if the Loan to Value Ratio (LVR) exceeds 80%.

Another important factor to note regarding the potentially long lead-time between signing Off the Plan purchase contracts and completion, is that your loan pre-approval is only generally valid for approximately 90 days, which means that you will most likely need to undertake another full home loan assessment. Where this can negatively impact you, is if your circumstances have materially changed and the lender decides that they can no longer assist you with the finance. In this case, your 10% deposit is at risk of being lost if you cannot complete the purchase.

Final Thoughts

Borrowers should consider the above prior to making unconditional offers for house and land packages and/or off the plan purchased, and where unsure, seek professional advice. Failure to do so, may result in committing to a property that may not be able to be funded in a traditional manner and therefore may come at a considerably higher cost to the borrower.

We have assisted several of our clients with construction finance, not only in the home and residential investment lending space (to which this article applies) but also in the commercial construction/property development space which includes (but not limited to) commercial property (e.g. industrial/retail/offices) development, multi-apartment and/or townhouse construction and land subdivision. So, rest assured that we have the expertise and experience to assist you with construction finance for projects of any scale.

Disclaimer: The information provided herein is for general information purposes only and does not constitute specific advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific advice should be obtained from a suitably qualified professional before adopting any investment/financial strategy.