Renovations can add value, and you might not need to take out new loans to pay for them.
22 December 2021|4 minute read
Renovations can increase your property’s value and help you work toward designing your dream home.
If you have sufficient equity in your home, you could avoid having to take out a new loan or making a dent in your savings to pay for your renovation.
Here we’ll go through what home equity is, how to access it, the downsides, and the alternative ways to fund your renovation.
Home equity refers to the difference between a property’s value and how much is owed on the home loan. Equity is the portion of the property’s value that the homeowner owns outright.
For example, if your home is currently valued at $600,000 and you have $300,000 left to pay on your mortgage, your home equity is $300,000 (50%).
Equity isn’t just determined by the amount of money put towards the property through the deposit and home loan repayments. It can also be impacted by:
● Value-increasing home renovations
● Changes in the property market that affect property values
So, in some instances you can technically grow your equity without actually paying down your mortgage.
Some borrowers with an interest-only loan will sell their property at a profit despite not making any loan repayments. This could be due to improvements made on the home, or the property naturally increasing in value due to market conditions.
If you know what your home is worth, calculating your equity is easy.
Equity can be calculated by subtracting the outstanding home loan balance from the up-to-date property value.
For example, if you owe $500k on your home loan and the property is now valued at $1 million, you have $500k in equity on the home. This equates to a 50% Loan to Value Ratio (LVR).
There are even a number of online calculators that will do the work for you.
In general, homeowners have access to up to 80% of their home’s equity, but this can vary between lenders and based on how you intend to use the funds.
You can access your equity by refinancing your home loan.
Refinancing isn’t just for switching lenders or getting a lower interest rate, you can access cash from your equity with a line of credit home loan or a cash out loan.
Before you apply to access your equity, take the time to calculate the likely cost of your planned renovations.
Remember that you will likely end up spending more than what you’d like, but you can start by getting quotes from contractors and designers.
A cash out loan, also known as a home equity loan, can help a homeowner tap into the equity they’ve built in their property.
This kind of loan may be easier to qualify for than a line of credit loan because your property will be used as collateral against the loan.
Your lender will determine the amount of equity you can access by considering the following:
● How you intend to use the loan funds
● The current value of your property
● Credit score and financial situation
● Your Loan to Value Ratio (LVR)
● Property market conditions.
Bear in mind that whenever you dip into your equity, you are increasing the amount you owe on your home loan.
Your lender will assess your financial situation to determine how well you can service a line of credit or other home equity loan.
As equity builds up in your property, you may be able to access it through a transactional facility that has a credit limit, kind of like a credit card.
This is known as a line of credit and is a common way that homeowners fund their renovations, but may also fund things like holidays and new car purchases.
However, it’s important to be realistic with yourself and ensure that your accessible equity will be sufficient enough to fund your renovation plans.
If you’re interested in accessing your equity for renovations, it’s a good idea to speak with your local Aussie broker. They can talk you through your options and act as a bridge between you and your lender.
When you use funds from your equity, you’re increasing the amount you owe on your home loan that you still have to repay within your existing loan term.
This can result in stress, as well as the possible need to reassess your finances and budget.
Although it is a worst case scenario, you can even risk losing your home if you are unable to make your new loan repayments.
Having an available stream of money can be tempting to spend on other things unrelated to your renovation.
If you are someone with poor money management skills, this is something to be wary of when considering tapping into your equity.
As you take money from your equity, you are increasing the amount you owe on your mortgage, which will likely increase your Loan to Value Ratio (LVR).
If you borrow over 90% LVR you may be required to pay Lenders Mortgage Insurance (LMI).
There are some fees that may come up when you try to access your home equity. These may include:
● Break costs
● Valuation fees
● Legal fees
There are also potentially higher interest rates to deal with when you have an equity loan.
For larger renovation projects that require structural changes, a construction loan could be a more suitable option.
This loan option is generally unsuitable for smaller scale renovation projects, like a kitchen renovation.
You may be able to cover some renovation costs with a personal loan and/or credit card.
While it depends on the lender, the maximum personal loan amount in Australia tends to be around $50,000 to $60,000.
Remember that personal loans and credit cards often attract higher interest rates than home loans. So, consider how interest charges could add to the overall cost of your renovation.
If you have a redraw facility and have made extra repayments, you may be able to redraw these to help fund your renovations.
Rather than considering loans and dipping into your equity or additional repayments, you can go the old fashioned route and save up!
This will take a little longer, but it’s a good option if you don’t want to increase your debt.
You could end up building some great financial habits along the way too.
While doing renovations yourself won’t be possible for all projects, it can be a more affordable solution.
For example, if you want to re-do your kitchen, but can’t quite afford a full renovation, you may be able to give it a refresh yourself.
Consider repainting cabinets, replacing handles and appliances, adding in a tiled backsplash, or even installing some floating shelves.
Accessing your home’s equity could be the way to finance your renovations. Speak to your local Aussie Broker to find out if it’s right for you.