The difference between ordinary home loans and building loans

This is what you need to know about the two types of home loan which banks are prepared to grant.

Loans

If you are buying an existing property or a newly-built home – freestanding or in a development – you would apply to the banks for an ordinary home loan to finance your purchase.

However, if you build your dream home, buy a plot-and-plan house in a development, or carry out alterations to your existing home, you will need a building loan. In spite of its name, the loan can also cover the purchase of the stand on which the house is to be built.

For both loans, the amount granted by the bank will depend on the property purchase price and the size of the deposit you are able to put down. This applies whether you are a first-time buyer or a repeat buyer.

Ordinary loans

Two types of ordinary home loan are available – variable and fixed rate.

  • With a variable-rate loan the interest you pay on the outstanding balance of the loan rises and falls in line with the prime rate. This means it will be influenced by macro-economic factors such as the inflation rate, the monetary exchange rate and fluctuating fuel prices.
  • With a fixed-rate loan the interest you pay is set for a specified period – usually for two years. The advantage of this type of loan is that it allows you to budget with certainty, as your monthly repayment amounts remain unchanged regardless of changes in the prime rate. One disadvantage is that the interest rate charged on fixed rate loans are higher than on variable-rate loans. Another disadvantage is that you will get no benefit if the prime rate decreases during the period in which your rate is fixed.

For both variable and fixed rate loans, the interest on ordinary loans is calculated daily on the outstanding balance, and debited to your home loan account monthly.

Building loans

For a building loan, the bank makes progress payments to the building contractor as each stage of the construction work is satisfactorily completed. The bank will usually retain a final payment until you have signed off on the completed building work.

To apply for a building loan, the bank will require all the same documents needed for an ordinary loan, such as your identity document, proof of address and proof of income.

In addition, the bank will ask for:

  • Approved building and site plans.
  • A detailed building contract and schedule of completion from your builder.
  • Proof that the builder is registered with the National Home Builders Registration Council (NHBRC).
  • An all-risks insurance policy for the construction.
  • A waiver of contractor’s lien in favour of the bank. A contractor’s lien is a common law right which entitles a contractor to remain in possession of his client’s property as security for payment in respect of work performed on the property.

In many cases, the bank will ask loan applicants to pay a deposit of at least 10% of the cost of the build, to finance any shortfall between the loan granted by the bank and the eventual cost of completing the project.

Affordability

Instalments on ordinary home loans and building loans are payable monthly on the due date in terms of your home loan agreement with the bank. The usual repayment period is 20 years, although some banks are willing to extend this to 30 years.

Before applying for either type of loan, make sure that your credit record is spotless, and that you will be able to afford the monthly repayments.