How to use your home equity to fund renovations :
Home is where the heart is, but what if your heart demands more from your home?
There’s been a great deal of change in how people think and feel about their homes in the past year. According to a survey by Australian bathroom retailer Blue Space, more people plan to spend their savings on renovations than on holidays. The top reasons for renovation include wanting to refresh an old room, making changes that add value to the home or create more space for a growing family.
Funding your home renovation project
Lifestyle changes in the past year have forced several homeowners to rethink their homes and add more value by creating functional spaces. However, whether you want to refresh your interiors with a new coat of paint or add an extra room or floor, renovation projects are not cheap, and you need to know your options before undertaking one.
Lockdown living has led to increased savings for some families, largely due to cancelled holiday plans. If you’ve been saving up diligently during this time, it’s likely you have a few thousand dollars to put towards your home renovation project. But if you’re considering something more than a minor touch up,you’ll probably need to borrow some money to get the project going.
While there are several ways for financing a home renovation project, including taking out a personal loan or using your credit card, tapping into your home equity could be cheaper in comparison.
What is a home equity loan?
A home equity loan is probably the most common financing option for home renovation projects. Equity refers to the current value of your home minus the amount outstanding on your mortgage. Given the recent increase in property prices, you’re likely to have substantial equity in your home, especially if you’ve had the house for a few years and have been diligently making your repayments.
So, if your property’s present value is $800,000 and you owe $450,000 on your mortgage, the difference between the two ($350,000) is your home equity. However, you won’t be able to borrow the full value of the property. You can usually increase your borrowing to up to 80 per cent of the property’s value without paying Lenders Mortgage Insurance (LMI). In this example, you can increase your total borrowing to $640,000, which is 80 per cent of the property’s value. Now, subtract the amount already owing on your loan from this number to get your usable equity ($640,000 – $450,000), which is $190,000 in this example. This means you can borrow up to $190,000 using a home equity loan.
Most borrowers use an equity drawdown to fund minor renovation projects (like upgrading a bathroom or the kitchen) costing up to $100,000. You can either use a top-up facility or take out a second loan on the property to release your equity. For major renovations involving structural work, it’s usually helpful to consider a construction loan. A construction loan for a pre-approved amount releases funds in stages to directly pay the builder at the completion of each subsequent milestone in your project. You only pay interest on the money that has been drawn down, saving you a lot over time.
Refinancing your home loan to unlock your equity
A loan top-up is one of the options to use the equity in your home by sticking around with the same lender and mortgage terms. However, you don’t need to continue with the same lender unless you want to. If you find there are better and more competitive home loan deals on the market, you can refinance and renovate at the same time to score a better deal from another lender.
However, this option is usually more suitable if you’re on a variable rate, as refinancing a fixed interest loan can lead to you paying an unnecessary break fee. It’s also important to compare other refinancing costs vis-à-vis the interest rate and features on a new loan to decide whether it’s worth making the switch. Remember, it’s not about getting the cheapest home loan possible but one with helpful features that will make it easier for you to manage the mortgage in the long run. Speaking to a mortgage broker could help you assess your options to find the best possible way to finance your renovation. As brokers work with multiple lenders, they also make it easier to choose the right lender, which is one that is most likely to approve your home loan, meets most of your objectives and offers a competitive rate.
It’s also worth remembering that tapping into your equity will increase your borrowing and decrease your ownership of your home. This could see you making larger monthly repayments if you continue with the same loan duration or staying in debt longer if you refinance to another 30-year term. Refinancing to a longer term could be more expensive in the long run, despite a low interest rate, as you’ll be paying interest over an extended period. Therefore, it’s worth considering your present financial situation and long-term goals before deciding to dip into your home equity to finance a renovation project. For smaller amounts, you may consider other options, such as redrawing some of the extra repayments you made into your home loan.
