New year, new home renovations

New year, new home renovations

If you’ve been thinking about renovating your kitchen, or making your home more sustainable and environmentally friendly, now could be the perfect time to start planning.

With property prices on the rise and interest rates at record lows, 2020 could be the year to make your dream home a reality, or to upgrade your property and increase your equity.

Why would you get a loan to cover your home renovations?

Improving your home with renovations can be costly, in terms of labour and material cost, so it’s common to borrow money to fund these projects.

There are a few benefits to getting a loan to cover your renovation.

  • Because you need to determine your loan size, it forces you to work out how much you need to spend in advance.
  • It motivates you to stick to your budget as you only have the loan amount.
  • You can complete your renovation on time as you’ll have the funds available
  • After the holiday period, cash flow can be tight and a loan can help with this

If your renovations are to increase your sustainability, there are now ‘green’ loans available that can help you purchase solar panels, energy efficient lighting or to fund other projects that reduce your environmental impact. The main benefit to sourcing these loans is that they can offer lower rates than standard personal loans.

If you are looking to get finance for a home project, you might consider getting a cash out refinance, a home equity loan, a construction loan or a personal loan.

Using your existing home loan to cover the costs

If you want to use your existing home loan to fund your home renovations, there are two popular ways to do this.

Get a home equity loan

A home equity loan is where you use the equity in your home as collateral on your loan. Equity is determined by calculating the difference between what the bank values your house at and the amount you owe on your home loan. As your property price increases and you make your mortgage repayments, you are effectively reducing your loan balance and increasing your equity.

These loans essentially act as a second mortgage on your home where you use your property to secure the loan and reduce the lender’s risk. Borrowing additional funds on your home loan can save you time and means you don’t have excessive forms to fill out, and could mean you get a lower interest rate than you would with a personal loan.

Access your redraw facility

Some home loans offer a redraw facility, which means you have the ability to make extra repayments on your mortgage above the required monthly repayment, at no extra cost to you.

If you have this feature, and have made many additional payments into your home loan, you may want to check if the money in your redraw account will fund the project you wish to carry out. If so, you may have the ability to withdraw these funds as cash to finance your home renovations, without taking out a second mortgage.

However, if you decide to redraw the extra money you have put into your home loan, check there are no excessive redraw fees that apply. Some lenders may also decline certain redraw request, so make sure you check with your lender that you are able to redraw these funds before you decide this is the best option.

Organising a cash-out refinance to boost your equity

Home renovation projects can present you with a good opportunity to review your home loan. Specifically, the new year is a good time to look at your current interest rate, as you may in fact save thousands by switching to a lender with a lower rate, or by switching to a different home loan with your current lender.

Refinancing can provide you with the opportunity to get a cash out refinance, increasing your loan limit and withdrawing the difference in cash. This essentially replaces your existing loan with a new loan, with different terms and conditions, so be sure to check the fine print before you sign anything.

The amount you will be able to withdraw will also depend upon the equity you have built in your home, how much you have paid off your Loan to Value Ratio (LVR) and your current loan term.

If you decide to refinance your home to get cash out for your home renovations, make sure that you do not commit to a much longer loan term. Agreeing to extend the length of your loan term could mean you incur tens of thousands of dollars more interest than your original loan, so be sure to check the loan in detail before you apply.

Funding an extension or additional structure with a construction loan

If you’re looking to build a small extension or a granny flat as a part of your home renovation, you might consider getting a construction loan to finance it. These types of loans cover the expenses you incur as you build, and are a popular alternative for those who are looking to have their funds released in ‘stages’.

Releasing funds in this way can ensure you save money and improve your cash flow whilst the constructed extension or additional structure is being built and not yet in use.

Construction loans often allow you to pay interest only until the construction is complete, however be sure to remember that interest only payments do not reduce the principal loan amount.

Some lenders may also only need a 5 per cent deposit of the total building cost to get started, which could help with your cashflow.

These stages are:

Slab – building the foundation of your home, including the base, plumbing and waterproofing - often approximately 10 per cent of the total amount.

Frame – constructing the ‘frame’ of your home including the windows, roofing and some brickwork - can be around 15 per cent of the total amount.

Lock up – covers the elements that are needed to ‘lock up’ your home, including external walls, doors and insulation - typically 35 per cent of the loan.

Fixing – shelving, kitchen, bathroom cabinets, tiles, cladding and all other internal fixtures and fixings are included in this stage - ordinarily about 20 per cent of the contract.

Completion – the completion of the building contract which includes all final installation pieces, including building property fences, cleaning, painting etc - usually the remaining 15 per cent of your loan amount.

Getting a personal loan to cover your renovation costs

If you only have a small project to complete, don’t have a home loan to borrow against, haven’t built enough equity, or don’t have a redraw facility, you might consider opting for a personal loan.

Personal loans may have slightly higher rates than home loans, but much lower rates than credit cards, so if you don’t have a home loan to borrow against, this could be a good option for you.

Variable rate personal loans secured with collateral may have the added benefit of allowing you to make additional repayments, so you can pay the loan off sooner and save on interest. These are known as secured personal loans, as the collateral increases the security of the loan, and reduces the lender’s risk.

This feature is often not provided with an unsecured personal loan, however, as the bank sees this type of loan as higher risk. These types of loans also have higher rates due to the increased chance you will default on your repayments.

If the reason you’re renovating your property is to make it more environmentally friendly, there are some lenders who offer ‘Green Personal Loans’ with lower rates than standard personal loans to encourage eco-friendly activity.

Investing in sustainable home renovations like solar panels and energy efficient hot water systems can reduce the overall running cost of a home. As such, this could likely increase the value of your property due to the cost savings that energy efficient products can bring.

This can make your home a more attractive investment for buyers in the market, and could potentially increase the equity in your home.

 

Which is the best option for me?

There are many different ways in which you can finance your home renovations, but as with all financial products, it's important that you find what works best for you.

Every individual is different, and the interest rates and products you will be eligible for will depend upon your income, expenses and your individual financial situation.

Before you apply for any financial product, make sure you compare all your available options, check for fees and charges that apply to each, and be sure to check the fine print.

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Learn more about home loans

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.

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. 

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.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

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 building in course of erection loan?

Also known as a construction home loan, a building in course of erection (BICOE) loan loan allows you to draw down funds as a building project advances in order to pay the builders. This option is available on selected variable rate loans.

What is a debt service ratio?

A method of gauging a borrower’s home loan serviceability (ability to afford home loan repayments), the debt service ratio (DSR) is the fraction of an applicant’s income that will need to go towards paying back a loan. The DSR is typically expressed as a percentage, and lenders may decline loans to borrowers with too high a DSR (often over 30 per cent).

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

Who offers 40 year mortgages?

Home loans spanning 40 years are offered by select lenders, though the loan period is much longer than a standard 30-year home loan. You're more likely to find a maximum of 35 years, such as is the case with Teacher’s Mutual Bank

Currently, 40 year home loan lenders in Australia include AlphaBeta Money, BCU, G&C Mutual Bank, Pepper, and Sydney Mutual Bank.

Even though these lengthier loans 35 to 40 year loans do exist on the market, they are not overwhelmingly popular, as the extra interest you pay compared to a 30-year loan can be over $100,000 or more.

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.