Renovations: the great Australian pastime. We spend in excess of $30 billion doing up our homes every year, according to the Housing Industry Association - but how are we funding this?
Rather than taking out a new loan or dipping into savings, many of us are making the most of what we've got, and tapping into equity that already exists in our homes. Here's how it works.
Calculate your equity
Equity is essentially the difference between how much your home is worth and what you owe on your home loan. If you've got $200,000 left on a mortgage when your home is worth $500,000, then you have $300,000 of equity.
Equity accounts for both what you've paid off your home loan and the growth in a property's value over time - the higher the capital gain, the more equity you'll have.
Once you've calculated your equity, you can determine how much you're able to access for renovations. This involves reworking your home loan, and many lenders won't let you tap into all of your equity - you will still have to comply with LVR limits. This is why financial advice is crucial before you move forward - you have to know exactly what you can borrow, and what you want to spend.
How accessing equity works
If you're looking to perform cosmetic renovations (that is, fixing up the kitchen or bathroom, or repainting walls) and you have at least 20 per cent equity, then you can take out a line of credit loan. The maximum amount you can borrow is 80 per cent of your loan-to-value ratio.
For larger-scale renovations that involve structural changes (such as replacing or removing foundations and walls, or replacing plumbing or electrical wiring), you may need a construction loan. With these, the maximum borrowing amount is based not on the property's current value, but on the predicted property value upon completion of the construction.
It's important to figure out how much renovations will set you back by budgeting carefully.
Estimate how much your renovations will cost
Draw up a budget and figure out how much everything will cost you - and be specific. Renovation costs can magnify exponentially if you're not sensible, so factor in even those minimal costs so that you have as accurate a picture as possible, especially as costs vary widely depending on geographic location and the scale of your renovations. Standard kitchen renovations cost on average $17,000 Australia-wide, according to Domain stats, but you could be up for as much as $42,000 if you live in Sydney.
Once you've got a ballpark figure, you might realise that you don't have enough equity at this point in time to finance the renovations you want to do. In this case, you may decide to either wait for your equity to increase, or consider a different financing option.
It's always a good idea to have a contingency plan in place.
Even if you do have enough equity to fund your renovations, it's always a good idea to have a contingency plan in place - ideally around 20 per cent of the total renovation cost - in case your costs increase.
Build up funding in your mortgage
If you know that renovations will cost you $65,000, then you need a plan of attack to save up the necessary funds. This could mean making additional mortgage repayments to build more equity.
Get a home loan with maximum flexibility - one that allows you to make payments of more than the minimum amount. You can pay extra into your loan, a redraw facility or an offset account so that you can access the funds later on when you start renovating.
If you plan to extend or make more than just cosmetic changes to your property, taking out a construction loan is your best option.
Before you decide to use your equity to fund your renovations, do your due diligence and budget carefully. Ensure you have a backup plan in place in case renovation costs end up being more than anticipated. Then, pursue a strategy that will allow you to build your equity over time so that you'll have enough to use for the improvements you plan to make to your home.
It's vital to get quality financial advice before taking any big steps. While using equity to finance renovations might be the best option for one household, it may not be the most suitable option for you. Advice from a trusted and experienced adviser will ensure that you make the best decision for you.
Got any questions about financing your upcoming renovations, taking out a loan or property investment? Yellow Brick Road's financial advisers give Aussies like you quality financial advice and access to the most competitive financial products. Come and talk to us today.