Refinancing for a renovation
Have you always wanted to renovate but you’ve always been worried that you don’t have enough money?
Contrary to popular belief, renovations don’t always have to end in you losing money. If you refinance wisely you could actually be adding value to your home.
If the word ‘refinance’ has you scratching your head in confusion, you’re not alone.
According to the Australian Bureau of Statistics, lending to households for refinancing fell 2.6% in September 2019. This shows that many Australians are forgetting that refinancing is an option.
So, what is refinancing, and can you use it to your advantage when renovating?
What is refinancing?
Refinancing is the process of replacing your current home loan with a new one.
It is usually done because the new loan is a better fit; whether that be because it has a better interest rate, more extra features (such as access to redraw or offset accounts), or sometimes people refinance to get access to their equity (including those who need funds to renovate).
Although there are misconceptions about the amount of work it can take to refinance, if you ask those who have done it, they’ll tell you it’s well worth your while – and not as complicated as you might think! (At LoanCaddie, our brokers will even fill out the paperwork for you!)
And while a small difference in interest rates may seem insignificant right now, over the long-term switching to a lower-rate can save you thousands of dollars (and far out-weigh the cost of refinancing).
How can you refinance to renovate?
If you don’t know where to start, how here’s how you should go about refinancing to prepare for your renovation:
The first step is to research! Before you go to your lender, consider getting a property valuation in order to determine how much equity you have in your home and research the value of homes in your area.
Using your research, set a budget for how much you want to borrow to fund your renovation. You won’t want to borrow more than 80% of your property’s value or 10% more than the median property value in your area. A good tip is to use our borrowing power calculator to help you with this process.
Assess your current home loan rate and search for a more competitive rate with a different lender.
Apply for a new loan with the lender and let them know about the extra money you want to borrow. You will then go through the process of leaving your old lender.
Once your loan is approved, you can now renovate away!
Why refinance to renovate?
By switching to a more favourable lender, you may receive a more competitive rate and better features. This will save you money in the future and these savings can go straight to your renovations. While it may seem like you are increasing your debts, the benefits will outweigh any costs in the long run.
When you go through changes in life, your needs change too. Similarly, changing up your home loan will mean you will have different needs and preferences when it comes to the features of your loan.
Refinancing means you can find a loan that is tailored to suit these needs. Whether you want to switch from a fixed rate to a variable rate, or you want to more flexibility with your repayment arrangements or you want a split loan- there’s an option for everyone so don’t be afraid of change!
By refinancing to renovate, you will also be able to add features to your home that will make it more attractive on the property market. The value of your home may also increase, increasing your profits if you choose to sell.
Can I use my equity to renovate?
If you have paid off more than 20% of your home loan, or your home has increased in value, you likely have available equity which you could use to get a loan to cover renovation costs.
Equity is a little bit like ‘hidden money’. Your home’s equity is the value of your home minus how much you have paid off. In most cases, you will be able to take out up to 80% of your equity (leaving the remaining 20% against your home loan to avoid lenders mortgage insurance).
To use your equity in this way, you would need to have your home valued, and then refinance your current home loan to give you access. You would then be able to use this equity to help secure a loan for the renovations.
Since a home typically rises in value over time, it’s not unusual for people to discover they have much more equity than what they would have thought.
For example, if you took out a $300,000 loan for your home 10-years ago but have paid off $200,000 of this, you would have $100,000 left outstanding.
However, over the time you have owned the property, it has increased in value to $500,000. Therefore, you have $500,000 – $100,000 = $400,000 of equity in your home, of which you would be able to use $320,000 (80%) of this on another loan.
It should also be noted that using your equity in this way will increase your debt. However, for many, this is worth it since the funds are used to increase the value of assets – which may work out better in the long run. If unsure if it’s the right move for you, ask your accountant or financial advisor for professional advice before proceeding.
Can I use a line of credit to renovate?
Adding a line of credit to your home loan is also an option to get funds to renovate. A line of credit allows you to access some of the equity in your property, only you don’t need to withdraw it all at once. Instead, it is credit that is there if you need it – which can be great for paying off tradesmen etc.
This also means that you’re only paying interest on funds you have actually withdrawn, which is often a better option than taking out a whole loan.
However, line of credits usually have establishment and upkeep fees, which are worth weighing-up with your broker before going down this path.
Is refinancing the right option for you?
There are a few things you should be wary about before you choose to refinance. If you don’t have much equity in your home or your property is of low value, then you might have trouble with the refinancing process. This is because your loan may not be approved or you may have trouble paying it off in the future.
You should also be aware that it typically takes a few weeks to make a new mortgage application. When switching to a new lender, you may also have to pay exit or switching fees. But don’t despair if refinancing isn’t a possibility for you – there are always alternative options such as taking out a construction loan or using redraw.