Once you’ve planned for your renovation, you’ll need to decide how you will pay for the project, and how much you can afford to spend.
When it comes to finances, what works well for one person may be the completely wrong choice for another. It’s very important you work out exactly what your renovation project is going to cost and then consider your financing details based on your own personal financial situation.
Line of credit
A personal line of credit is one of the most commonly used forms of finance for smaller-scale renovations. By applying for a line of credit, you establish a revolving credit line that you can access at any given time. While a line of credit offers greater flexibility compared to a regular mortgage, it’s important to consider that you will have two home loans against your home and two monthly repayments to budget for.
For small upgrades, you may not need to apply for new finance if you can leverage features of your existing mortgage. If your current home loan has a redraw facility, attached and you’ve managed to make some additional repayments, you may be able to access those funds.
For homeowners with sufficient equity, refinancing with a mortgage top-up may be the easiest option for sourcing additional funds. Most lenders will limit the amount you can withdraw in cash from a refinance. For example, you may be limited to increasing your loan top up to a maximum of 80% of property value.
To illustrate, if your home is valued at $500,000 and you already owe $350,000 you may only be able to top your loan balance up to a maximum of $400,000, giving you $50,000 for your renovation.
Some lenders may request information on how you intend to spend the additional funds. If you have quotes from builders to complete a larger renovation project, some lenders may turn your mortgage top-up into a more rigidly controlled construction loan instead.
If your existing mortgage is locked into a fixed rate and you’re unable to top it up through refinancing, you may be able to apply for a split loan. This lets you avoid any penalties or break costs for amending your fixed-rate loan.
The lender will assess the total loan amount you’re able to borrow and then create a new loan account alongside your existing fixed-rate home loan. Most lenders will limit the total amount of both loans to a certain percentage of the property value.
So, if your home is valued at $500,000 and your existing fixed-rate mortgage is $350,000, then your second mortgage account will be limited to a maximum of $50,000. This gives you total borrowings of $400,000, which is 80% of the property value.
If you haven’t built up any equity in your existing property, it may be difficult to qualify for other types of finance and thus a personal loan may be a more suitable option. Just be cautious of the higher interest rates that are generally associated with personal loans.
For smaller-scale projects, such as upgrading a kitchen or a bathroom, you may want to consider a personal loan.
Larger-scale renovation projects, such as those that require a licensed builder to complete, may need to be financed through a construction loan. Generally, lenders structure construction loans differently to traditional mortgages. Instead of forwarding all the money you borrowed on the loan settlement day, the lender divides the total amount into components. The builder then issues an invoice for a percentage of the total bill amount as each stage of your renovation is completed. The lender draws a portion of your total loan amount to pay each invoice. When the renovation is finished, the builder invoices for a final time and the bank pays it using the remaining funds in your construction loan.
A specialist construction home loan may be a good idea, particularly as the lender will take into account the improved value to your home when determining your borrowing capacity.
Pros and cons of using credit for your renovation
- An unsecured personal loan can be repaid over a shorter term than a mortgage.
- If you don’t have equity in your home, a personal loan may be easier to qualify for than a mortgage.
- Personal loans are generally approved faster than mortgage applications.
- Unsecured personal loans attract a higher interest rate.
- You need a good credit history to qualify for an unsecured personal loan.
When a personal loan may be cheaper than a mortgage top-up
When comparing a personal loan to a mortgage top-up, many argue that a mortgage top-up is a more affordable option due to the higher interest rates attached to personal loans. However, there are some instances where using a personal loan for a renovation may be more cost-effective in the long term.
For those renovators who haven’t built up sufficient equity in their home, a personal loan may be a more viable option. This is because many lenders place limitations on the loan-to-value ratio (LVR): for instance, you may only be able to borrow 80% of the property value.
An investor may wish to renovate the property before they sell it for a profit. In this case, the investment strategy is to add as much value as possible and then sell the property for the highest possible sales price.
What should you ask your lender when renovating?
Before you sign on the dotted line for your building contract or finance documents, make sure you prepare some questions for your lender.
What fees are involved?
Always ask what fees and charges are involved in setting up your loan. Some lenders will charge application fees or establishment fees. Some will charge a monthly account fee you need to pay on top of your normal monthly payment. Others may charge a separate valuation fee or legal fee to set up your loan. If you’re borrowing a high percentage of the property value, ask how much you’ll be charged for your Lender’s Mortgage Insurance (LMI) fee.
What is the comparison rate?
While the advertised interest rate may appear competitive, always check what the comparison rate is. If you see a comparison rate that is only marginally higher than the actual interest rate, you know you aren’t being stung with additional fees and charges. However, if the comparison rate is quite a lot higher than the advertised interest rate, ask what fees apply to your loan.
What loan features are available?
Different types of home loans will have a range of different features attached to them. Look for features such as flexible repayment options, which allow you to make extra payments without penalties. You may also want to consider a redraw facility, so you can withdraw additional payments if you want to use that cash for other things later.
A portability option is also handy for some people, as you’re able to take your loan with you if you sell one house and buy another. This saves you the hassle of setting up a new loan. Always check that the features on the loan you choose to suit you and your financial needs.
Terry, your friendly mortgage broker