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Two ways to fund a renovation

Wednesday, 2nd Oct 2013

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Planning a renovation? One of the difficult decisions you will face is how to pay for it. You have 2 main options when it comes to getting a loan for a renovation.

In Australia, renovating is one of the most popular reasons for refinancing, whether it is for lifestyle purposes or to add value to a property. But one of the many difficult decisions facing would-be renovators is how to pay for the renovation.

Some people may have savings or the ability to redraw funds from their home loan. Others may use a credit card or personal loan as a quick way of getting the money they need. But most renovators, especially those planning large renovations, will need to organise financing.

You have 2 main options when it comes to getting a loan for a renovation.

The first is to borrow against your equity, which either involves increasing or refinancing an existing loan or taking out a new loan on an existing property. This is probably the most common method because it’s relatively easy.

The amount you can borrow is determined by the amount of equity available and the lender’s servicing criteria. Typically, you can borrow up to 80 percent of the value of the property without paying Lender’s Mortgage Insurance (LMI), but every lender has different policies.

With an equity loan, interest only starts accumulating when equity is drawn down. This is why these loans require discipline because the money can essentially be used for anything.

The key thing to remember about this type of renovation financing is that the lender won’t take into account the post-renovation value of your property, which could limit the amount you can borrow.

If you don’t have enough equity to fund your renovation, you could consider another option: the construction loan.

This sort of loan is similar to an equity loan but in this case the lender will take into account the finished value of the property when determining how much to lend you. This means you could potentially borrow a larger amount, making the loan a good option for more substantial renovations.

Like an equity loan, interest on a construction loan is only charged when money is drawn. But the lender won’t give you all the money upfront because a construction loan is a riskier prospect for the lender. The money is generally released in stages as the renovation progresses, just as if you were building an entirely new home. This gives the lender more control and ensures the money is not used for other purposes.

Getting approval for a construction loan may require you to have council-approved building plans and a fixed-price building contract in place. Plus, the lender will not only organise a valuation pre-renovation but also assess the project at each stage before an instalment is paid. When the project is completed the loan will generally revert to a standard variable loan or you may be able to refinance to a loan of your choice.