Refinancing a mortgage to pay for renovations

Whether you’re installing a granny flat or upgrading your kitchen, paying for the material and labour costs of a home renovation is never cheap. One option homeowners have to pay for these projects is to refinance your home loan to free up equity.

Also called a cash-out refinance, this option lets eligible homeowners tap into their home equity by refinancing the home loan to a new lender and increasing the loan balance. The difference may be withdrawn in cash to pay for the renovations.

Some lenders may also offer you this difference in the form of a line-of-credit. Some borrowers may find this option better suited for long-term renovation projects, as it offers periodical payments when needed (up to the credit limit).

So, how do you know how much money you have available to access, and how easy is it to refinance to free up equity?

How much home equity do you have to pay for renovations?

Your equity is the difference between the current value of your home and the outstanding amount on your mortgage. If you’ve been making regular mortgage repayments for a few years, and your property has increased in value since you purchased it, you may have built up equity that can be leveraged to pay for a renovation project.

This doesn’t mean you can borrow the entirety of your equity, as the home loan lender will still require some of your loan balance to be paid off – similarly to how you applied with a deposit of 10-20%. Instead, you may be able to borrow the ‘available’ equity in your property, which is a limited percentage of your equity to ensure your loan-to-value ratio (LVR) stays around 80%.

For example, using the Domain Home Equity calculator, a homeowner with a property valued at $1,000,000 with a $650,000 mortgage balance would have an estimated available equity amount of $150,000.

Pros and cons of refinancing for home equity to pay for a renovation

It’s worth keeping in mind that refinancing your home loan is a significant financial decision that shouldn’t be made lightly. There are several factors worth comparing that can influence the repayments and total cost of your mortgage when you refinance. It’s important to compare the interest rate, fees and features offered by a lender when switching your home loan.

Refinancing to access equity for a renovation may have greater advantages for your property’s value. If the home improvement project boosts your current home value, then it’s likely to further increase your home’s equity even after you’ve dipped into it to renovate. Plus, if you’re looking to sell the home soon, this may have the added impact of increasing your sale value.

If you refinance to a lower-rate lender as well, it’s likely you could save thousands in interest charges over the life of the loan. Or if you refinance to a new mortgage with helpful features like an offset account, this could also decrease the amount of interest charged. There are several benefits to refinancing a home loan that are worth exploring, not just regarding how you could access equity in your home.

When you refinance, you are moved on to a new lender’s home loan term. Sometimes a lender may re-extend this loan term if you’re not diligent in the refinancing process, bringing your loan term back to 25-30 years. If you only have a few years left remaining on your current loan term, try to avoid tacking on extra decades of repaying the mortgage by accident.

Most significantly, by refinancing to free up equity you’re likely going to increase your home loan balance in the process. Your next home loan repayments may be higher because your loan balance has been increased. This is where prioritising lower rates, fewer fees, or the ability to make extra repayments in your new home loan can help mitigate this risk.

Pros:

• Pay for your renovations
• Boost your property value
• Nab a more competitive home loan

Cons:

• Loan balance is increased
• Risk of extending your loan term

If you aren’t sure about the financing option that’s best for you, discussing your requirement with a mortgage broker may help. A decent broker will help you evaluate your choices better and could also try to negotiate a more favourable rate and terms with your lender.

Before you sign on the dotted line…

When planning a renovation project, it’s easy to see how the total cost can quickly spiral. To keep the costs under control, consider discussing your plans with an expert and getting a. quote for the project. Once you have an estimate, you may have a better understanding of exactly how much accessible equity you will need to use.

This can also help you determine if the improvements are likely to add value to the home or not, which could impact your final decision to go ahead with the plans. For example, you might be considering some cosmetic changes to your bathroom without realising the extensive plumbing work it might entail. An expert will tell you about these costs in advance so you can plan your budget accordingly.

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