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Restructuring to fund your home renovation

10/07/2020

Restructuring your existing loan could unlock equity and free up some cash.

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If you’ve been contemplating a large scale renovation on your home, then the recently announced HomeBuilder program might be welcome news. To help support the construction industry through COVID-19, the program will provide home owners with a grant of $25,000 to carry out substantial renovations provided the build meets certain eligibility criteria, including:

  • The property is owner occupied (unfortunately investment properties are excluded)
  • Contract is signed between 4 June 2020 and 31 December 2020
  • Renovation contract is valued between $150,000 and $750,000
  • The value of your property does not exceed $1.5 million
  • Your income is less than $125,000 as an individual or less than $200,000 combined as a couple
  • Construction commences within three months of the contract date.

While it’s easy to get carried away with styling ideas and grand plans, it’s important to consider your financing options before you get started. Renovations can be stressful enough, but you may be able to refinance your current home loan to free up some cash or include the additional costs.

Refinancing is often referred to as switching or transferring, but you’re actually paying out your existing loan and creating a new one in its place to take advantage of better features or a lower interest rate, either with your existing bank or a different lender. 

How much can I borrow to renovate?

To figure this out, you need to consider two things – how much equity you have in your property, and your property’s loan-to-valuation ratio (LVR).

Equity explained

Equity simply refers to how much your home is worth, minus the outstanding amount you still owe. So for example, you bought your home 10 years ago for $500,000. Your home is now worth $800,000 on the property market and in the past 10 years you’ve paid $100,000 off the home. The ‘equity’ in your home – the amount the home is worth minus what you owe – is $400,000.

LVR explained

The loan to valuation ratio is important when you are refinancing to renovate, as it can determine how much you can borrow or if you’ll be required to pay mortgage insurance, which can be quite expensive. The LVR is calculated by dividing the amount borrowed by the market value of the property, expressed as a percentage. For example, if you buy a home for $500,000 using a $450,000 loan and a $50,000 deposit, the LVR would be 90%.

To estimate how much additional funds you can borrow, you first need to determine the current market value of your property (many real estate websites provide free estimates). Then, find out how much you still owe on your property and subtract this from your current property value. This will provide you with the equity you have in your property. Multiply this figure by 80 percent and the result is what you may be able to borrow without paying for Mortgage Insurance.

So if we go back to the example above, if your equity is $400,000. Multiply that by 0.8 and you get $320,000, which is the amount of money you should be able to borrow without paying Mortgage Insurance – but of course, this will depend on other factors such as your assets, other loans you may have, income and so on.

When borrowing for a renovation, your bank will likely do their own valuation of your property and generally, it is best to speak to your lender to get the most accurate indication of the amount you may be able to borrow.

How you can use your existing home loan to renovate

The type of renovation you’re doing can dictate the loan type that will best suit your needs. Here are some options:

  • Line of credit (LOC) loans: Ideal for cosmetic renovations like kitchens or bathrooms, these loans are like having a credit card with a larger limit. A LOC enables you to draw on the existing equity you have in your property. However, you will probably need to provide up to 20% of your own funds.
  • Construction loans: If you’re knocking down and rebuilding or doing a large renovation like an extension, a construction loan could be ideal. The total borrowing amount is not based on the home’s current market value, but on what it would be worth at completion – so you may have access to a larger sum to renovate. However, to qualify for this type of loan you’ll have to have council-approved plans in place and a fixed-price contract with a builder.
  • ‘Top up’ your current loan: This means borrowing extra funds on top of your existing home loan which you can access with a redraw to pay for renovations. It’s not available on all types of home loans, so check with your lending if it’s available to you as it could be a cost-effective solution.

Are there any other costs to consider?

In a word, yes. You may need mortgage insurance if your overall home loan debt goes above 80 percent of the value of the house, which could end up becoming quite expensive.

You also need to be aware that restructuring or refinancing to access existing equity may increase how much you owe and subsequently your increase monthly repayments and overall loan term.

The HomeBuilder grant is subject to eligibility and application criteria, details can be found at www.revenue.nsw.gov.au. This article is intended to provide general information of an educational nature only. It does not have regard to your objectives, financial situation or needs and must not be relied upon as financial product advice. Before you act on this information, you should consider whether it is appropriate for your circumstances. Information in this article is current as at the date of publication. Applications subject to credit approval and fees and charges are payable. Terms and conditions apply and are available on request.

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