5 ways to finance your renovation

Australia’s renovation boom saw home owners and investors spending an average of $76,000 on house improvements, according to realestate.com.au’s Property Seeker report. 

This figure further rises to $107,000 for those renovating with the aim of selling or leasing their property.

However, a separate study by comparison site Finder revealed that while almost half of all Aussies can afford to fund a renovation out of their savings, the remaining 53 per cent need to access some type of lending. 

If you’re an investor or a home owner looking to fund your renovation project, here are several loan options and financing sources that may be available to you.  

What kind of loan do I need for a renovation?

Here are the different loan types that investors and home owners can use for their renovation projects: 

1. Construction loans

If you’re taking on a large renovation project such as an extension of your property or a knockdown and rebuild, then a construction loan could be the way to go.

How do construction loans work? Typically, the loan amount will be based on the estimated post-renovation value of your property, which gives you the capacity to withdraw whatever amount you need to pay the latest renovation-related invoice that has come in.

This means that borrowers for this type of loan receive their money in increments. And because you are paying each bill as it comes, you won’t need to pay interest on your building costs until work has actually been completed — giving you better cash flow. 

This type of home could be in addition to the existing mortgage on your property (also known as a second mortgage). In some cases, you could refinance your existing home loan to be a construction loan, depending on the lender’s rules and what best suits your needs.   

So, what do you need to apply for a construction loan? When you apply for a construction loan, the lender usually requires a copy of the building contract/tender and the plans.

Afterwards, the bank or lending institution will request their valuer to provide an estimate of the on-completion value of the property and will evaluate your loan on the lesser of the land price in addition to the cost of construction or the on-completion value.

Remember that with this type of loan, lenders will also request invoices from builders and contractors in order to release the next “drawdown” of funds.

Pros of construction loans

• Low-interest option 
• Loan applications are processed and approved quickly and easily 
• One single home loan to pay (if debt is restructured) 
• Significant cash amount available if the property has built up a lot of equity 

Cons of construction loans 

• The higher loan balance means longer payback period 
• Requires ongoing communication between borrower, lender and contractors 
• More interest rate charges in the long run 

Smart tip: 

Remember that as you draw down more of your loan, the amount of interest you pay will start increasing. You’ll need to account for this in your cash flow. 

2. Personal loans 

Another option for funding your renovations is a personal loan. A personal loan will typically allow you to borrow up to $50,000, but some lenders may have higher lending limits. 

Research from comparison site Finder showed that around 17 per cent of Australians would consider using a personal loan to pay to bring their renovation plans to life. 

A personal loan can come in two forms: secured or unsecured. Generally, secured finance will be cheaper than unsecured finance because lenders have collateral that they can leverage if the borrower defaults on their loan. 

However, keep in mind that the interest rate on this type of loan can widely vary and will depend on the financial product, the terms and conditions, as well as your credit history. 

Pros of personal loans 

• Applications are often processed quickly
• Usually require no collateral for unsecured personal loans
• Fast, lump-sum funding 

Cons of personal loans 

• Often carry high-interest rates 
• Managing another repayment aside from your home loan
• More expensive option when compared to funding the renovation via a mortgage

Smart tip:  

Keep in mind that repayments on personal loans tend to be higher than regular loans because the loan term is shorter. With this, it’s advised to take on a personal loan if your renovation is small (e.g. simple cosmetic renovations) and won’t require significant expenditure.

3. Refinancing your home loan

Refinancing your home loan could be an option to consider when looking for a way to finance your renovation.

The idea behind refinancing to renovate is to secure extra cash that will fund your renovations. 

In order to gain the renovation capital, you will need to switch or refinance with a new or existing lender and increase the amount you owe to the lender. 

Start your refinancing plan by looking at your existing home loan rate and comparing it to similar products in the market.

After finding a similar mortgage with a lower rate and features that suit your needs (such as an offset account or redraw facility), use a borrowing power calculator to get an understanding of how much you can borrow and what your repayments would be like with a higher mortgage. 

Then apply for your new loan. Once approved, your new lender will help you with the process of leaving your old lender.

Pros of refinancing your home loan

• Low-interest option compared to a personal loan or a credit card
• Refinancing to a lower rate means more savings 
• Maintain one payment

Cons of refinancing your home loan

• Longer application process compared to personal or construction loans 
• Usually comes with closing costs such as exit or switching fees from your old loan (particularly if you have to break a fixed rate) and fees for the new loan 
• The new loan may potentially default to a 30-year loan term, making it even longer until you own your home or investment property outright

Smart tip:

If you don’t have much equity or the value of your property has declined, then refinancing might be more challenging or could even cost you lenders mortgage insurance (LMI) if your loan-to-value ratio (LVR) rises above 80 per cent. 

4. Home equity loan 

A home equity loan can let you borrow against the equity in your home, which you can use for any purpose, including renovating your home or investment property. 

Equity refers to the difference between what you owe on your property (loan balance) and its current value. For example, if you owe $500,000 on your home loan and your home is currently valued at $750,000, you’ve built up $250,000 in equity.

With a line of credit loan, you can tap into this equity. Of course, your lender will offer you a credit limit based on your equity, and you can use as much or as little as you like.

You can think of it like a line of credit attached to your home loan; only every dollar you spend adds a dollar of debt to your home loan.

Pros of a home equity loan 

• Offers flexibility since once approved, you can use as much or as little of your credit limit as you need
• You’ll only be charged interest on the amount you’ve actually used for your renovation project

Cons of a home equity loan 

• This type of loan usually comes with a higher interest rate than standard mortgages 
• Can be difficult to manage. Since you have easy access to the funds, it’s very easy to overspend
• Stricter lending criteria, making it harder to secure approval 

 Smart tip:

With a home equity loan, your repayments will rise based on how much money you access, so make sure you’re financially capable of shouldering your repayment amount.

 5. Other financing options to consider for home renovation

If your renovation is likely to require a smaller cost, there are some other types of finance that may be appropriate. For example, you could consider a credit card to fund your renovation. 

However,  most experts advise against using a credit card in financing your renovation, as the high-interest rates can add a hefty premium to the total cost of your renovation. 

Instead, property owners are recommended to consider it as their absolute last resort. 

Additionally, you could also look out for grants or interest-free loans that may be available in your state or local area for certain kinds of renovation work. 

For example, some states and territories in Australia offer incentives and grants to first home buyers purchasing a property they plan to renovate. 

Disclaimer: The information provided should be taken as general information and does not replace professional advice. We strongly recommend consulting with a licensed mortgage broker or financial adviser when seeking financial guidance that will be best suited to your objectives and financial situation. 

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