How to finance your renovation when interest rates are soaring
Renovating your home at any time can be stressful, let alone when you throw rising interest rates into the mix Some homeowners will simply hold off until the official cash rate stabilises, but if you’re one of the homeowners keen to push ahead regardless, keep these tips in mind.
How is a renovation financed?
If you don’t have enough cash in the bank for your reno and are opting to lend from a bank as opposed to a non-bank or second-tier lender you will need to apply for what is termed a construction loan.
What exactly is a construction loan?
It’s a lump sum that’s approved by your bank for the purposes of funding your renovation project. While the full lending facility will most likely be visible in your online banking, you will only be able to draw down on it as and when your bank approves invoices for payment. The benefit of this is that you’re only ever paying interest on the sum you’ve spent and not the whole amount – especially considering this is usually charged at a floating interest rate. Sometimes you can fix the first half once spent, then the second half upon completion, but that depends on your bank.
How do you obtain a construction loan?
Whether you’re working directly with your bank, or via a mortgage advisor, both will generally want to see a breakdown of anticipated costs and a copy of your builder’s quote prior to confirming finance and, on occasion, the builder’s contract also. As you submit invoices during construction, they will likely be ticking off the scope quoted versus invoiced to ensure the two align and you’re not at risk of budget blowouts.
Knowing how much to borrow
When it comes to setting a budget for your renovation, the best thing you can do is actually start by finding out how much money your bank will lend you. Often homeowners get right the way through design, consent and quoting before even mentioning the project to their bank or mortgage advisor, then when they aren’t able to borrow enough to cover the quote, they have to go through a redesign process. This can be especially hard for homeowners when they’ve already bought into a design and subsequently have to pare it back.
To avoid this, find out what you can borrow first, then subtract 20 percent for contingency and work with the balance figure. Remember that design and consent easily takes up another 15-20 percent, which means only 60-65 percent of what you can borrow should be allocated to the actual construction.
Value today versus value tomorrow
Once you’re through the design and consenting process, if your bank hasn’t approved enough for the cost of construction (including a contingency), then one of the ways you can challenge this is by obtaining a current registered valuation for the house as well as an estimated value of what it would be worth if your proposed renovations were completed today. The difference between these values is the anticipated value added from the renovation.
Hopefully it exceeds the cost of your proposed works as that means you can expect some capital value unless the market goes backwards during construction.
The moral of the story is be prepared. Proper renovation planning is critical to preventing budget blowouts on renovations projects anyway, but it’s also critical to your refinancing process as without a detailed budget and comprehensive drawings, your bank either isn’t going to lend to you or they’re going to account for the risk by limiting what you can borrow. The best place to start if you’re thinking of doing a renovation is to find a mortgage adviser.
Words by: Jen Jones
Jen is not a financial adviser. For custom advice contact a mortgage adviser.
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