How To Finance Your Renovation
Every homeowner considers renovating at some point, from a major extension to a coat of paint. But it costs to do a makeover.
To DIY you need tools and equipment and to call in a professional means paying an invoice.
Like all financial questions, how much is too much comes down to the benefit you get in lifestyle or potential resale value compared to the outlay, and the hardest part is paying the bills.
Most people spend everything they earn on a monthly basis.
So it appears the only way to pay for anything is by accruing debt.
Assuming you have enough equity in your property and a reasonable capacity to repay, banks are more than happy to sign you up, even in this supposed climate of restraint.
Depending on the scale of the reno you might be forced into a construction loan at a higher interest rate with the option of rolling it into your mortgage when the bank is convinced you’ve added enough value to their security.
Some seeking a loan think that paying a mortgage broker will get them the cheapest interest rate, because that’s how mortgage brokers convince you to sign with them rather than the banks.
So how do you pay for the reno you want?
It depends how you look at debt. It’s obvious you can spend more in a lifetime if you limit the interest you pay, so it’s important to relate to debt better.
This difference in perspective is the largest single thing that separates the independently wealthy from those who retire on only an age pension.
Most mortgages are designed to keep you in debt, especially those with offset accounts or lines of credit. As with credit cards it’s too easy to view the bank’s money as your own.
There is no perfect solution but the best approach is to look at debt differently. Rather than consolidating it, which is what banks and mortgage brokers say to do, approach it in bite-sized chunks instead.
In the worst-case scenario homeowners pay tradies using a credit card as a quick-fix solution.
For small-scale renos it’s unlikely refinancing the mortgage makes economic sense because of the fees.
But the interest on a credit card is at least twice that of the average mortgage.
If you’re tempted to put the revamp on the card then you can’t afford it.
The only sure way of saving interest is to avoid debt.
Having said that, for large-scale renovations debt can be used as a tool to make the unaffordable attainable.
If you borrowed $200,000 from your bank at 6 per cent over 30 years the repayments would be about $1200 a month or $14,400 a year.
The interest would be about $12,000. At the end of the first year you would have paid just $2400.
It can be disheartening to see so little paid and saving momentum can be lost.
But if, instead of looking at debt as a whole, you perceive it as 20 lots of $10,000 repayments, at the end of the year you’d still have paid $2400, but that equals nearly a quarter of the smaller amount.
The maths is exactly the same but your attitude is different and the satisfaction and sense of progress is greater, so you’re likely to save more.
The best loan isn’t necessarily based on the lowest interest rate, it’s also about how it’s structured, how you approach repayments and unlearning what you’ve been conditioned to accept when it comes to debt.
Home equity loan
Equity is the difference between what you owe to the financial institution and what your home is worth. A home equity loan allows you to borrow against this amount.
If your loan has a redraw facility and you’re ahead on payments you may be able to draw on the excess funds you’ve already paid.
If your loan doesn’t have a redraw facility, consider refinancing and taking out a whole new home loan, with the same lender or another financial institution.
Line of credit
Similar to a credit card but with lower interest, this is secured with a mortgage against your home and allows you to withdraw funds up to a set limit any time, with repayments made in full or monthly.
A good option if you need a little extra to finish the job. Because the (usually high) interest rate is fixed for the term of your loan you know exactly how much you’ll be paying back and when it will be paid out.
If you’re planning a big extension, a construction loan may be offered. Funds are drawn to pay for each stage so you only pay interest on the money as you use it. It’s only drawn down to a registered builder you’re contracted with.