Financing your renovation

Once you’ve planned for your renovation, you’ll need to decide how you will pay for the project, and how much you can afford to spend.

A type of financing that works well for one person may be the completely wrong choice for another. It’s very important you work out exactly what your renovation project is going to cost and then consider your financing details based on your own personal financial situation.

Do your research and compare your options, but you can read more about some of the common renovation financing options by clicking the link below.

What should you ask your lender when renovating?

Before you sign on the dotted line for your building contract or finance documents, make sure you prepare some questions for your lender.

What fees are involved?

Always ask what fees and charges are involved in setting up your loan. Some lenders will charge application fees or establishment fees. Some will charge a monthly account fee you need to pay on top of your normal monthly payment. Others may charge a separate valuation fee or legals fee to set up your loan. If you’re borrowing a high percentage of the property value, ask how much you’ll be charged for your Lender’s Mortgage Insurance (LMI) fee.

What is the comparison rate?

While the advertised interest rate may appear competitive, always check what the comparison rate is. If you see a comparison rate that is only marginally higher than the actual interest rate, you know you aren’t being stung with additional fees and charges. However, if the comparison rate is quite a lot higher than the advertised interest rate, ask what fees apply to your loan.

What loan features are available?

Different types of home loans will have a range of different features attached to them. Look for features such as flexible repayment options, which allow you to make extra payments without penalties. You may also want to consider a redraw facility, so you can withdraw additional payments if you want to use that cash for other things later.

A portability option is also handy for some people, as you’re able to take your loan with you if you sell one house and buy another. This saves you the hassle of setting up a new loan. Always check that the features on the loan you choose suit you and your financial needs.

Over-capitalising on a renovation project

One of the major drawbacks of renovating is the risk of overcapitalising: when the cost of the renovation outweighs the amount of value added to the property.

If you’re renovating your home and you intend to live in the property for an extended period of time, then the risk of over-capitalising may not be as high. You may have spent $75,000 on the renovation and only increased the property value by an additional $25,000, but if you’re not selling in the immediate future then this isn’t automatically problematic. Given that you’ve purchased in a good location, you have time for inflation and appreciation of prices to kick in.

However, if your intention is to increase the value of the property, sell and make a profit, you could be in for a shock. Far too many investors underestimate the real amount of money they need to spend and overestimate the amount they’ll get on resale of the property.

You have two options if you spend too much on your renovation. You can sell the property anyway and take a loss on the amount you spent, or you can hold onto the property and hope that the market turns in your favour over time to help you recoup some of your costs.

Case Study: John and Jane

John and Jane wish to spend $15,000 on a complete kitchen renovation. They know they can top up their mortgage easily at an interest rate of just 5.75%. By comparison, they’re quoted 10.25% on an unsecured personal loan.

John immediately wants to sign up for the cheaper mortgage top-up option, but Jane does some quick calculations to look at the differences and alternatives.

 Home Loan Top-UpPersonal Loan
Loan Amount
$15,000
$15,000
Interest Rate
5.75%
10.25%
Loan Term
30 years
5 years
Monthly Repayment
$87.54
$320.55
Total Interest Paid
$16,512.93
$4,233.24

In this example, the monthly repayments for the mortgage option seem so much more affordable at just $87.54 per month, as compared to paying $320.55 per month on the personal loan.

However, choosing to top-up the mortgage means repaying the renovation costs over a 30 year loan term. By comparison, the personal loan is set over a 5 year term. While the initial monthly payments might be higher, John and Jane can pay off their debt in just 5 years.

Aside from this, the amount of interest they end up paying if they opt for a 30 year mortgage is $16,512.93 overall. They end up paying more in interest than the original amount they borrowed.

Yet if they repay the renovation debt over a 5 year personal loan term, they end up paying just $4,233.24 in interest charges.

Based on this example, a personal loan may be the cheaper option for this renovation project.

How to lessen your renovation risk

In order to avoid over-capitalising, you shouldn’t spend more than 15-20% of the property value on your renovation.

However, it’s still important to consider how much value you can realistically add to a home in the local market. You should conduct some research into the local property market regarding median property prices, median rental yields and price growth trends.

Get your home valued so you know exactly how much it’s worth in its current state and seek the services of a conveyancer and local agent so you know how much value you can potentially add once your project is finished. Look at similar properties in your suburb and take note of the sale price. Consider when the properties will sell and contact a local agent to see what the sale price was and consider whether the sale price is significantly lower than the initial asking price.

You can access free suburb reports from CoreLogic, Residex and realestate.com.au which can provide useful information regarding property sales, median prices and demographics.

This market research can also help you decipher which types of renovations are more likely to add value to your property. For instance, some real estate agents may advise for you to upgrade your bathroom and kitchen to achieve a better sale price in the given suburb.