Clients often say to me: “We want to renovate our home. We need to re-stump the house or add another bedroom for the kids…and we do not have the cash available to pay for the work. How can we do it?”
Waiting and saving the money to afford the work might be a sensible idea but it may not be a realistic one. It could take from 6 months to 6 years (or longer) to save the money.
Then there is the small matter of timing. The work might need to be done urgently as…the arrival of a new child is looming, the leaky roof will not last another winter or you cannot stand the thought of another 6 months in the draughty old bathroom.
So how can you fund the home improvements?
Well, there are a number of options, but the starting point is to answer to 5 important questions:
- What is your house currently worth?
- What would you like to do to your house?
- How much will it cost to do this work?
- What will your house be worth at the end?
- Can you afford the higher mortgage? (in the eyes of both you and the bank)
Option 1 – Borrow against your home equity
All the hard work that has gone into paying off your home loan is rewarded right here. We may simply be able to increase your loan limit to give you the funds you need for the home improvements.
Example: Dave owns an apartment in St Kilda worth around $400,000. His current home loan balance is $280,000 and he needs $40,000 to fix up the kitchen and bathroom. If we increase his home loan to $320,000 the total loan is still at 80% of the value of the property, so Dave meets the bank’s lending criteria (provided Dave can show the bank he can afford the higher repayments).
This option is generally best where your current home loan debt is less than 80% of the value of the property, and the work to be done is non-structural so the bank does not need to see plans for the improvements.
Option 2 – Borrow against the future value of your home
Another option is to ask a bank to lend you money based on the value of your home post renovation. Here you present the bank with plans for the proposed renovations and a fixed price building contract from a registered builder for the work. The bank then values the property based on its worth at the end of the renovations and lends you money for the renovations accordingly.
As the bank is now lending you money based on the “on completion” value of the property the bank will place tighter controls on the release of the money lent to you.
Payment for the renovations will be made by the bank to the builder in line with the payment terms set out in the fixed price building contract. Under this option, it is more difficult for you to do the work yourself as an owner-builder and this will only be possible with a few lenders, at higher cost and with more conditions.
Example: Simon & Patricia own a 3 bedroom house in Yarraville worth around $430,000. They want to renovate the bathroom and add another bedroom. A builder has quoted $165,000 to do this work. They are confident that at the end their home will easily be worth $600,000. Their current loan is $300,000 and if they need to borrow the entire cost of renovations the total debt will be $465,000. The bank will lend the extra funds here as the total loan will be less than 80% of the $600,000 value of the home on completion.
Option 3 – Renovate on credit cards and then refinance
Here, the home owner pays for the cost of their home improvements using their own cash reserves or credit cards. To do this, the home owner may in fact apply for 1-2 new credit cards or increase the limit on their existing cards to ensure they have access to sufficient credit card limits to cover the expected costs.
Then at the completion of the renovations, they go back to their bank (or any lender) and ask it to increase their existing loan to payout the credit card debts based on the new value of the property.
A home owner may wish to proceed in this way where Option 1 is not possible, they want to perform much of the work themselves, or the works are minor and therefore they do not want to have to go to the lengths of a formal fixed price contract with a builder.
The downside of this option is that credit card interest rates are usually higher than home loan interest rates. So I recommend you minimise the length of time you are paying this interest on credit cards.
Each option has its advantages. Option 1 is attractive where you have more than 20% equity in your home and don’t need to make major structural changes to the house.
Option 2 is the way most home owners proceed and is appropriate when there is insufficient equity in the property.
Option 3 is attractive where you want to take your time, feel you can save on building costs and are confident you can commute the credit card debt to a revised home loan upon completion of building works.
If you are looking to your fund renovations, please call me to review your individual circumstances so that we can help you find the right option for you.