Have you been meaning to get that new kitchen or extension to spruce up (and add value) to your home but you’re simply short of funds?
If your savings or extra repayments in your mortgage offset account aren’t enough to cover the cost of a major renovation – don’t fear, there’s another option available to you.
Refinance your home for renovations
Many banks are happy to refinance your mortgage for renovations using either:
- Your home’s existing value; or
- An improved home value (called on completion value)
In this post, I’m going to cover what each of these refinancing options means for you and how you can get the most out of them. Stop putting off your renovations TODAY!
When to use your home’s existing value
Refinancing using your existing equity means that the current value of your home is used by the bank to determine how much you can borrow.
Using your own equity is suitable for smaller projects such as new kitchens and bathrooms, landscaping and painting – generally projects that cost $100,000 or less.
Here’s an example of how it works:
- Say you have $50,000 in your mortgage offset account
- You currently owe the bank $450,000 but your home is worth $600,000
- If you refinance your mortgage to 80% of your home’s value, this means you can now borrow up to $480,000, meaning you can borrow an additional $30,000
- Combined with your existing savings of $50,000, you would have $80,000 to use towards your renovations
Benefit of using your home’s existing value
The main benefit of using your existing equity is that the bank will normally refinance without you needing to provide lots of paperwork – this is usually a fairly quick process so you can start your renovations sooner!
Pitfalls to watch out for
The main disadvantage with this approach is that you are limited by your home’s existing value. If you wanted to borrow more than 80% of the value of your home, you would need to pay Lenders Mortgage Insurance (LMI).
Because you’re limited in how much you can borrow, it’s tempting to keep the costs of renovating down. This means you might skip on a building contract and DIY instead. If you’re not experienced, this can lead to all sorts of problems – such as time and cost blow outs, issues with tradies and worst of all, no insurance cover if things go wrong. Tread carefully if you plan to DIY!
When should you use an on completion value?
Refinancing using an on completion value means that the bank will assess the value of your home after renovations when deciding how much to lend to you. This means you can borrow more than simply if you used your home’s existing value.
Using an on completion value is suitable for structural or major improvements such as extensions, adding storeys or adding rooms – generally projects that cost $100,000 or more and which also add more value to your property.
If we continue with the example above:
- Say you wanted to add a new kitchen and another bedroom with ensuite for a total cost of $180,000
- In the first example, you would have only been able to borrow an additional $30,000 before paying LMI
- Based on comparable sales, you NEW home value would be worth $800,000 after renovations instead of $600,000
- If you refinance using an on completion value, you can now borrow up to $640,000 without attracting LMI
- This means you can borrow an additional $190,000 – more than enough to cover your renovations without you needing to even dip into your savings!
What you need in order to use an improved home value
Whilst you can borrow more under this approach, the process with the bank is a little more involved. You would need a fixed price building contract with a qualified and insured builder for the renovations in order to get the bank’s approval. And of course approved plans and drawings done (usually the builder/architect arranges this)
On first glance, this might cost more than a DIY job. However this gives you the security of:
- Fixed costs;
- More certain timing; and
- Builder’s insurance if it all goes wrong.
The right approach is key
The key to a smooth renovation is to plan appropriately and to not jump in without preparation. Plan for not only the building requirements but also for your finances. Speak to an experienced Mortgage broker and let them help you structure your mortgage for long term investment success