Can a home loan be used for renovations?

Can a home loan be used for renovations?

Traditional real estate advice says to buy the worst house in the best street – you can pay less today and renovate tomorrow. But renovating still costs money, so you may want to look into the options for using your home loan to help take care of your budget.

There are a few different ways you can potentially use a home loan to pay for a renovation, both directly and sometimes indirectly.

Get a construction loan

If a real estate listing uses phrases like “fixer-upper”, “renovator’s dream” or “bring your builder”, there’s a chance you may not be able to use a regular home loan to buy this property, as its value may not be enough to secure the mortgage. If a property (including vacant land) requires extensive building or renovation work, a special construction loan may be used to pay for it.

Unlike a traditional mortgage, you don’t receive all of the money as a lump sum at the start of a construction loan. Instead, you draw down money in stages as you progress through the project, to pay for each stage of construction. You’ll usually make interest-only repayments on the money drawn down from a construction loan until the work is completed, whereupon the mortgage will revert to a more typical principal and interest home loan.

Keep in mind that a construction loan is typically more involved than other home loans, as your lender will conduct regular valuations throughout the construction project to help ensure the property maintains its value. There may also be other terms and conditions involved, such as having the work carried out by qualified and licensed builders and tradespeople – it’s unlikely you’ll be able to do it yourself as an owner-builder, unless you have the right qualifications, licenses and insurances.

Borrow extra money to renovate

If you’re buying a property or refinancing an existing home loan, you may have the option to borrow a little more than you’d normally need and use this extra cash to pay for renovations.

Keep in mind that getting a bigger loan may require you to hold a bigger deposit or more equity, especially if you want to avoid paying for Lender’s Mortgage Insurance (LMI). Also, a bigger loan means making bigger repayments, costing you more from month to month.

Finally, by paying interest on the cost of your renovation over a term of 20 to 30 years, your project could ultimately end up costing a lot more in the long term than it would by paying for it upfront.

Use your redraw

Have you been making extra repayments on your home loan for a few years? If you’re well ahead on your mortgage repayments, there may be a simple way to renovate your property, using your home loan’s redraw facility.  

This mortgage feature lets you take any extra repayments you’ve previously made back out of your home loan again when you need them, such as for last-minute emergencies like medical bills or car repairs, or for projects like renovations.

Keep in mind that redrawing money from your home loan can effectively undo some of the good work you’d done of making the extra repayments in the first place. Extra repayments can help reduce your home loan’s principal, bringing you closer to exiting your loan earlier and shrinking your interest charges. Using this money for renovations may mean your loan takes longer to repay, costing you more in interest charges over the long term.

Unlock your equity with a line of credit

The current value of your home, minus the amount still owing on your mortgage, is called your equity. If you’ve been making regular mortgage repayments (including extra repayments) for a few years, and your property has increased in value since you bought it, you may have more equity available in your property than you realise.

Equity can be used for a range of purposes, including securing access to credit. A line of credit may let you borrow money against the value of your home equity, including spending on renovation projects.

A line of credit works a lot like credit card, except the maximum credit limit is effectively your home equity, so you can usually borrow more money. Much like a credit card, you’ll only be charged interest on the money you borrow, and the repayments are flexible. This can be handy if you plan to renovate a property over a longer period and pay off each stage of the project one at a time.

Of course, much like a credit card, it’s important to keep an eye on those interest charges, and avoid letting them build up to a point where you can no longer comfortably afford to pay off your debt.

Use a personal loan, secured by your equity

Another potential use for your home equity is to secure a personal loan, separate from your home loan. Secured personal loans often have lower interest rates than unsecured personal loans, and because they typically have shorter loan terms than home loans (often anywhere from 12 months to 10 years), you may pay less total interest on the cost of your renovations.

However, there are risks involved. Chiefly, if you default on personal your loan, this could mean losing your security – in this case, your house. Additionally, personal loans often have higher interest rates than most home loans.

Did you find this helpful? Why not share this article?

Advertisement

RateCity

Money Health Newsletter

Subscribe for news, tips and expert opinions to help you make smarter financial decisions

By signing up, you agree to the ratecity.com.au Privacy & Cookies Policy and Terms of Use, Disclaimer & Privacy Policy

Advertisement

Learn more about home loans

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What is a draw down?

The transfer of money from a lending institution to a borrower. In a typical home loan, the funds are drawn down all at once in order to buy the property. In a construction loan, the money is drawn down in several stages to pay the builders as they progress through each phase of the project. In a line of credit loan, you can draw down money up to a limit based on your loan’s available equity.

How can I pay off my home loan faster?

The quickest way to pay off your home loan is to make regular extra contributions in addition to your monthly repayments to pay down the principal as fast as possible. This in turn reduces the amount of interest paid overall and shortens the length of the loan.

Another option may be to increase the frequency of your payments to fortnightly or weekly, rather than monthly, which may then reduce the amount of interest you are charged, depending on how your lender calculates repayments.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

What are the responsibilities of a mortgage broker?

Mortgage brokers act as the go-between for borrowers looking for a home loan and the lenders offering the loan. They offer personalised advice to help borrowers choose the right home loan for their needs.

In Australia, mortgage brokers are required by law to carry an Australian Credit License (ACL) if they offer credit assistance services. Which is the legal term for guidance regarding the different kinds of credit offered by lenders, including home loan mortgages. They may not need this license if they are working for an aggregator, for instance, as a franchisee. In both these situations, they need to comply with the regulations laid down by the Australian Securities and Investments Commission (ASIC).

These regulations, which are stipulated by Australian legislation, require mortgage brokers to comply with what are called “responsible lending” and “best interest” obligations. Responsible lending obligations mean brokers have to suggest “suitable” home loans. This means loans that you can easily qualify for,  actually meet your needs, and don’t prove unnecessarily challenging for you.

Starting 1 January 2021, mortgage brokers must comply with best interest obligations in addition to responsible lending obligations. These require mortgage brokers to act in the best interest of their customers and also requires them to prioritise their customers’ interests over their own. For instance, a mortgage broker may not recommend a lender who gives them a commission if that lender’s home loan offer does not benefit that particular customer.

What are extra repayments?

Additional payments to your home loan above the minimum monthly instalments, which can help to reduce the loan’s term and remaining payable interest.

What is a construction loan?

A construction loan is loan taken out for the purpose of building or substantially renovating a residential property. Under this type of loan, the funds are released in stages when certain milestones in the construction process are reached. Once the building is complete, the loan will revert to a standard principal and interest mortgage.

Do mortgage brokers need a consumer credit license?

In Australia, mortgage brokers are defined by law as being credit service or assistance providers, meaning that they help borrowers connect with lenders. Mortgage brokers may not always need a consumer credit license however if they’re operating solo they will need an Australian Credit License (ACL). Further, they may also need to comply with requirements asking them to mention their license number in full.

Some mortgage brokers can be “credit representatives”, or franchisees of a mortgage aggregator. In this case, if the aggregator has a license, the mortgage broker need not have one. The reasoning for this is that the franchise agreement usually requires mortgage brokers to comply with the laws applicable to the aggregator. If you’re speaking to a mortgage broker, you can ask them if they receive commissions from lenders, which is a good indicator that they need to be licensed. Consider requesting their license details if they don’t give you the details beforehand. 

You should remember that such a license protects you if you’re given incorrect or misleading advice that results in a home loan application rejection or any financial loss. Brokers are regulated by the Australian Securities & Investment Commission (ASIC), as per the National Consumer Credit Protection (NCCP) Act. 

How to break up with your mortgage broker

If you find a mortgage broker giving you generic advice or trying to sell you a competitive offer from an unsuitable lender, you might be better off  breaking up with the mortgage broker and consulting someone else. Breaking up with a mortgage broker can be done over the phone, or via email. You can also raise a complaint, either with the broker’s aggregator or with the Australian Financial Complaints Authority as necessary.

As licensed industry professionals, mortgage brokers have the responsibility of giving you accurate advice so that you know what to expect when you apply for a home loan. You may have approached the mortgage broker, for instance, because you have questions about the terms of a home loan a lender offered you. 

You should remember that mortgage brokers are obliged by law to act in your best interests and as part of complying with The Australian Securities and Investments Commission’s (ASIC) regulations. If you feel you didn’t get the right advice from the mortgage broker, or that you lost money as a result of accepting the broker’s suggestions regarding a lender or home loan offer, you can file a complaint with the ASIC and seek compensation. 

When you first speak to a mortgage broker, consider asking them about their Lender Panel, which is the list of lenders they usually recommend and who may pay them a commission. This information can help you decide if the advice they give you has anything to do with the remuneration they may receive from one or more lenders.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.