BEWARE! Watch out for split contracts and their impact on construction loans!

Over the last decade, a trend has been seen that house and land packages are becoming increasingly popular. However, a small faction of the packages are essentially different to others – they are called Split Contracts.

What is a split contract?

In most “house and land packages”, there are two contracts, one for the land with the developer, and the other for the construction with the builder, and these two are independent to one another. However, a “split contract” is essentially one contract pretending to be two – the land is sold and settled and is subject to the purchaser entering into a building contract with a specified builder. The following three restrictions will commonly be applied for split contracts:

  • No resale of the land
  • No choice of other builders
  • No choice of other types of construction.

Why are lenders concerned about split construction contracts?

There are a couple of legitimate reasons why lenders should be worried about these types of contracts.

Due to the nature of such contracts, the land market value will essentially be zero as there is no alternate or standalone use of the land. Therefore, it is inappropriate for property valuers to ascribe a land value apportionment for an independent piece of land.

As a result, lenders would not be able to fund the land as no proper value is given by valuers.

Additionally, restrictions in the resale of the land make the land as an unsuitable mortgage security due to the potential complex legal issues.

In cases of builders failing to complete the construction, the risks are substantially higher for lenders as they would not be able to appoint a new builder or sell it.

Why do some purchasers get split contract construction loans anyway?

Some developers or agents may unethically boast about buyers getting a split contract construction loan anyway.

Does this happen? Yes, but it should not have happened.

Once in a while, valuers or credit assessors may overlook the terms of the split contracts and treat them as a normal construction contract, and therefore approve the loan at the end. But for buyers, no one should rely on the mission impossible to fund one’s purchase.

Need help with a construction loan?

Want to talk to someone about your situation? You can contact us using the form below or call us  on 02 8288 9123.

Reservoir Finance is an independent (not owned by a bank or lender) mortgage broker based in Sydney that services Australians worldwide! Our unique approach of “responsible borrowing” is different to the responsible lending catch cry from by the banks and the media.

Contact us for a no-obligation, free assessment of your current situation. If you need help with a loan or construction project, we are more than happy to provide our thoughts and options for you.

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