How is a knock down rebuild loan structured?

When you knock down and rebuild, the property you already own becomes the land security for the new loan. Whatever you still owe on it is refinanced into the new construction loan at the start. If the existing mortgage is with the same lender, this is a variation; if it is with a different lender, it is a refinance and the old loan is paid out at settlement of the new one.

Lenders treat the land value carefully because the house on it is about to be removed. Some value the land only, some value the land with the existing dwelling, and most will note that the demolition reduces the security value until the new frame goes up. That is why many lenders want the demolition funded from your own money rather than from the loan.

The build component is the fixed price building contract amount, sometimes plus approved extras such as site costs, landscaping in the contract, and council or connection fees. It is approved at the start but sits undrawn. As the builder completes each stage, the lender pays that stage directly to the builder after a progress inspection.

Because the funds are drawn progressively, you pay interest only on what has been drawn, not the full approved amount. Repayments start small and grow with each stage until the final payment at completion.

The maximum loan is based on the lower of two figures: the total cost (land value plus contract price) and the on-completion valuation, which is what the valuer thinks the finished home will be worth. Most lenders lend up to 80% of that figure without Lenders Mortgage Insurance and higher with LMI, subject to serviceability.

The loan still has to be serviceable on your income. Lenders assess repayments on the full end balance, not the small interest only amount during the build, and many also add your rent during construction as an expense.

When the final progress payment is made and the occupancy certificate is issued, the construction period ends. The loan converts to whatever standard product was approved at the start, typically a principal and interest loan over 30 years, and full repayments begin. This is also the point where you can look at splitting, offsetting or refinancing if the construction lender is not competitive on ongoing rate.