Refinancing Your Home Loan to Renovate: Key Questions Answered

January 3, 2018


Once you’ve lived in your home and have and have paid off your mortgage for a few years, you may start moving into the natural next stage of home ownership: renovation refinancing. Because you’ve built up equity and hopefully have boosted your credit with a couple of years of consistent on-time mortgage repayments, refinancing your home loan to renovate may be easier than you think.

Close to one-third of mortgage holders choose to refinance and then renovate with their new loan. Giving your kitchen or bathroom a makeover, doing an attic conversion or any other cosmetic or structural upgrade won’t just add value to your property, it will also make the experience of living in your home more fulfilling. You are paying hundreds of thousands of dollars over the term of your loan to be a property owner – why not take advantage of all that your mortgage can provide?

The fact of the matter is, home renovations are pricey, not to mention stressful. However, by planning well and taking advantage of the cheaper financing you can get through your mortgage rate, instead of taking out a personal loan or using a credit card, you can make your renovation dollars go further. And, you’ll make enhancing your property more financially manageable.

With renovation refinancing, there are two primary ways you can approach your new loan. What type of loan you switch to depends on what type of renovation you are going to do.

What Loan Should You Use for a Cosmetic Renovation?

When you renovate, you can either upgrade a space you already have or make structural changes. Cosmetic renovations can include installing new appliances and furniture, upgrading materials and fixtures, and giving the walls a fresh coat of paint. They can make space look fresh, new and revitalised but don’t require you to have someone come in and change the plumbing or wiring, knock out walls or alter your foundation.

Bathroom and kitchen makeovers, redesigning your bedroom or living room, or making other aesthetic enhancements to your living space is all cosmetic. With these renovations, you should refinance to a line of credit loan, also known as an equity loan. This type of loan product essentially lets you use the equity you’ve already built up on your property to cover costs.

You’ll be able to qualify for a line of credit loan if you are planning to borrow less than 80% of your loan-to-value ratio. Here’s the thing. If you still owe $350,000 on your mortgage, on a property valued at $500,000, you can only borrow up to $50,000 for your renovation. This would give you an equity loan for $400,000, $50,000 of which you could access as a line of credit to pay for your renovation.

Line of credit loans are commonly used for renovation refinancing because they give you the most flexibility. You’ll be able to draw down the funds when you need to. This means you’ll have money ready to pay your contractor and interior designer. It also means you have the freedom to use the money for other expenses and purchases. The interest is only charged when you draw down the money. As a line of credit, just like a credit card, as you pay down your loan, you can access the funds again, up to your upper limit – which would always be $400,000 in the example given.

The only risk is if you aren’t good at managing your finances and are tempted to overspend, refinancing to a line of credit loan can be an easy way to continually increase your mortgage debt. You need to be responsible enough to pay off your loan, without continuing to take out more money. Another renovation five years later, a family holiday to Bali, a new car – it’s not challenging to come up with new reasons to spend money. If you aren’t paying down your mortgage faster than you are accessing your equity, you can add years to your home loan before it’s paid off.

What Loan Should You Use for a Structural Renovation?

If you are doing a major renovation, you may want to consider refinancing to a construction loan. With this type of loan, you’ll need to get council-approved building plans and have worked out a building contract with a set price with your contractor. The loan will be for the expected value of the property once the renovation is complete. This generally ensures you have more than enough financing to use to cover construction costs.

Your lender will also be more involved in the process. They will send out an independent valuer to check on your renovation during each phase of the project. This can be a huge advantage as you’ll have your lender working with you to ensure your builder is sticking with his or her schedule and budget.

Another plus of construction loans is you only pay interest as you draw down the money. That’s great news. For those first few months when your project is getting started and you only have to pay your builder a deposit, you only are responsible for paying interest on that amount you’ve used. This helps you save in the long run.

Should You Refinance Again When the Renovation Is Done?

With a line of credit home loan, you may want to refinance to a cheaper variable rate loan as long as you don’t need to use your equity. This can also stop you from overspending as you won’t have access to a line of credit at a low-interest rate any longer.

With construction loans, you may be able to simply roll your loan into your bank’s standard variable interest home loan, which means you won’t have to go through the refinancing process. Or, you can refinance to a different loan.

When Should You Not Refinance to Cover the Costs of a Renovation?

Refinancing your home loan to renovate isn’t always a smart option. There are cases where you will save more if you opt for a personal loan from your bank instead, even though you could probably get a much lower rate on your mortgage.

First, you need to consider the costs of refinancing. Because of the fees for switching loans, such as loan establishment fees, you’ll have to pay at least $1,000, if not more, just to switch to your renovation loan. If you’re only doing a minor project, such as a basic bedroom renovation, and you have some of the money you need saved up, it may not be worth it to refinance just to access a couple thousand dollars.

Another big reason to choose other forms of financing is if you would need to borrow more than 80% of your loan to value ratio. This would mean you’d end up having to pay lender’s mortgage insurance, or LMI, adding thousands of dollars to the cost of your refinance. Also, many banks won’t let you take out a line of credit loan if you don’t have enough equity built up.

How Much Will a Renovation Cost?

Renovations aren’t cheap. A standard bathroom renovation will cost close to $40k. Getting a new roof – from $20k to $30k. If you use high-end materials and designers, something as seemingly minor as a laundry room upgrade can cost well over $20k. An attic conversion can cost over $90k.

But, they are an important and highly desirable part of home ownership. They can improve the quality of life for your family and at the same time, increase the value of your property, which means you can make your renovation investment back when you sell your home.

To make sure you are ready to refinance and have enough money to cover the costs, take a few steps to set yourself up for success:

  • Get a valuation done so you know how much equity you have and how much you can borrow without going over 80% LVR.
  • Don’t get in over your head – try to spend less than 10% of your property value for a renovation.
  • Estimate the costs of your renovation and use a mortgage repayment calculator to get an idea for your repayment amount.

When you have enough equity built up in your home, doing that renovation you’ve had your heart set on for years can be rewarding. Compare the line of credit and construction home loans available to get the best deal on your refinance.

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