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Cost Plus Finance

June 15, 2024
News
Updates

Despite some slowdown in the property market, residential mortgage growth remains above pre-pandemic levels, according to the Australian Prudential Regulation Authority (APRA) with their latest statistics revealing that residential mortgage growth has persisted above pre-COVID-19 levels, even amid higher interest rates.

For the quarter ending 31 March 2024, the data indicates a 4.1% increase in outstanding residential mortgage credit compared to the same period the previous year, rising from $2.14 trillion to $2.23 trillion.

Both owner-occupier and investment lending showed growth, with owner-occupier lending up by 4.9% (from $1.42 trillion to $1.49 trillion) and investment lending up by 3.8% (from $642.7 billion to $667 billion).

This rise occurs despite challenges in mortgage affordability and serviceability, so whilst it’s harder to access the same level of borrowing of several years ago, it hasn’t stopped people from getting loans.

In this week’s newsletter, we explore the complications of cost-plus loans.

Lenders generally view cost-plus building contracts with caution as they pose several risks for them. The primary concern is the potential for cost overruns with this uncertainty making it difficult for lenders to determine the total loan amount required, potentially leading to funding shortfalls during the construction process​​.

Fixed-price contracts on the other hand offer more security and predictability, ensuring that the project’s cost remains within the agreed amount, which aligns better with the structured repayment plans of most loans​​.

To mitigate risks associated with cost-plus contracts, some lenders may impose stricter lending criteria, require more detailed cost breakdowns, or demand larger contingency funds to cover potential overruns. Borrowers might also face higher interest rates or reduced loan-to-value ratios due to the perceived increased risk​​.

So what lenders will play ball when is comes to cost-plus loans, and what are the criteria they impose in agreeing to the funding?

Cost-Plus Lenders

LenderPolicy Guidelines
Westpac
  • Maximum LVR of 70% (I.e. LMI not available).
  • Construction must be carried out by a licensed builder.
  • If valuer notes that quantity surveyor report is required, then Westpac will seek this (at the customer’s expense).
Bank of Melbourne
  • Maximum LVR of 70% (I.e. LMI not available).
  • Construction must be carried out by a licensed builder.
  • QS Report is required at the customer’s expense.
CBA
  • Cost-plus contract may be considered when the value of the building contract is equal to or greater than $1mill.
  • Max LVR of 90% (inclusive of LMI). Clients wouldn’t go on FHG as security value exceeds price cap limits.
  • Customers with non-fixed or cost-plus contracts should ensure they have equity available to cover the price fluctuations (or additional 5% of build price to be retained in savings post-construction).
  • Additional requirements for building contracts > $1 million:
    • A Costing Report will be ordered to obtain an independent confirmation of the cost of the construction. Costing reports may take up to 12 business days to be returned, please advise customers of this.
    • A costing report usually includes a 5% contingency allowance. You must include this amount in the overall construction costs to support any unexpected increases in building costs. These funds are to be treated as additional customer contribution and the borrower/s will need to demonstrate they hold sufficient funds to complete and if used, receipts are required to confirm payment to builder. Any contingency allowance which goes unused during the construction will be released back to the customer/s once the final progress inspection has been returned 100% complete.
    • Some contracts may include a retention clause where a percentage of the invoice is reserved in a separate account as per an agreement by customer and builder. Retention is not held nor controlled by the bank. Unless a second account is provided to the bank, invoices will be paid in whole to the BSB and account number on the invoice, the bank must pay the whole stage as per the progress payment schedule (if fixed price contract). Retention amount must be detailed on the invoice.
    • Customer and/or builder must hold the retention funds themselves.
Bank Australia
  • Max LVR is only 65%.
  • Lender also requires a minimum $1,000 monthly servicing surplus.
  • Minimum loan size $20k
  • Minimum valuations at base and completion. Cost covered on a package loan. With basic product the valuer cost is passed onto customer (circa $150).
  • Progress payments as per contract.
  • No additional fees other than standard.

Variable

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR.

1 Year Fixed

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR. At the end of the three year fixed period, the borrowers interest rate will revert to a standard variable rate for the life of the loan.

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