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How to refinance your home loan for renovations
Add value to your property and roll it into your mortgage by refinancing for home improvements.
Given how quickly home renovation costs can add up, refinancing your mortgage is an option worth considering if you’re looking to make some major home improvements. This is often done through a cash-out refinance, which lets homeowners with enough equity refinance for an amount greater than what they owe. The homeowner receives the difference as cash at closing, which can then be used to finance the renovations.
We’ll go over the refinance process and then show you a few alternatives for financing your renovations if a cash-out refinance isn’t right for you.
5 steps to refinancing for renovations
- Start by looking at your current home loan rate and comparing it against other products on the market.
- Find a similar mortgage with a lower rate and features that suit your needs. A loan with low fees will also be cheaper.
- Contact the new lender. Be sure to inform them up front about the extra money you wish to borrow for the renovation. Most lenders allow you to refinance up to 80% of your home’s value.
- Gather your mortgage documents and apply for the new loan. Try to keep your spending down for the months leading up to the application if you can — this may increase your chances of approval.
- Once approved, your new lender will help you leave your old lender.
When should I refinance to fund my renovation?
If you’re undertaking a fairly serious renovation then refinancing could help you unlock the necessary cash with a reasonable interest rate. And if you haven’t looked at your home loan for a while you may be surprised how high your rate is now. Switching to a lower rate can save you a lot of money.
Renovators who want to refinance should consider these issues:
- Refinancing requires a new mortgage application and this can take a few weeks. If you need the funds fast you might have trouble.
- Refinancing can come with fees from your old loan (especially if you’re on a fixed rate) and fees for the new loan.
- If you don’t have much equity or the value of your property has fallen then refinancing might be hard, or could even cost you lenders mortgage insurance if your LVR rises above 80%.
Alternative ways to finance a renovation
Home equity line of credit
A home equity line of credit, also known as a HELOC, allows borrowers to draw on the equity they have in their property. A common credit limit on these home loans is 80% of your loan-to-value ratio (LTV). To calculate your maximum borrowing, subtract your current loan balance from your property value and then multiply this figure by 80%.
Lines of credit can obviously only be used in situations where there is an available amount of equity to use. When a line of credit is approved, it is like a giant credit card attached to your home loan with an upper limit of your equity amount. It can be drawn on for any type of expense you like including investments, cars and of course, cosmetic renovations. Interest-only starts accumulating when equity is drawn down.
There is a huge amount of freedom with a line of credit home loan. This means they are suited to people who are disciplined financially as spending money on frivolous purchases could be tempting to some.
Home improvement loans
Home improvement loans are loans specifically suited to the purpose of building a property. Home improvement loans are particularly useful as the total borrowing amount is not based on the property’s current value, but on a predicted value at completion. Borrowers, therefore, have access to vast sums.
To qualify for a home improvement loan, city-approved building plans and a fixed-price building contract must be in place.
Your lender will appoint an independent valuer who will assess your builder’s work at each construction stage before the lender pays an installment. The beauty of this is that you have extra help on your side to force your builder to complete work at a high standard. In addition, interest-only accumulates on money drawn down — which is good for your back pocket.
Once construction is complete, borrowers can often refinance to the loan of their choice, or roll the loan over to the lenders’ standard variable interest home loan.
Unsecured personal loans
If you’re making smaller renovations that don’t require as much money or you don’t have much equity in your home, then taking out an unsecured personal loan may be a good idea to get your home improvement projects underway. With this type of loan, the interest rate is based largely on your creditworthiness and you’ll usually have shorter payback terms than line of credit home loans — typically between two to five years. Because this is an unsecured loan, the interest rates are usually higher than those for line of credit home loans or construction loans.
Line of credit vs. loans for home renovations
Line of credit loans can only be used for cosmetic renovations, while construction loans can only be used for structural renovations. Unsecured personal loans can be used for either type of renovation. When deciding what type of loan to take out, you need to think carefully about the type of renovations you are making and whether the scope of the renovations will creep into structural changes from the initial plans.
What loan is best for cosmetic renovations?
A line of credit loan or unsecured personal loan is generally suitable for renovations to change aesthetics. Renovations that only tidy up a property’s appearance, rather than alter the structure, are considered cosmetic.
Cosmetic renovation examples include:
- Installing a new kitchen, bathroom and flooring
- Giving the interior or exterior walls a lick of paint
What loan is best for structural renovations?
Unsecured personal loans and construction loans are generally suitable for structural renovations. Structural renovations are major endeavors that involve city-approved building plans and a licensed builder working in a fixed-price building contract arrangement. These are time-intensive projects that involve a level of expertise and certification above your average DIY renovator.
Structural renovations include:
- Altered or replaced foundations
- Removal of exterior or interior supporting walls
- New or replaced electrical wiring
- New or replaced major plumbing.
Keep in mind what you intend to do when planning your renovations. Do your due diligence and research all the options available to you.
Tips for refinancing to renovate
- Consider the costs of refinancing. There can be lender fees, title fees, closing costs and other costs associated with refinancing. So make sure the amount you’re taking out makes sense with the associated costs.
- Determine what your home is worth and calculate your equity. Compare your home to similar properties in the local market or have your home valued. This will give you an idea of the available equity you can tap into.
- Know which upgrades increase home value. Not all renovations add value to your home, like carpeting and wallpaper. In general, upgrades that add the most value:
- Increase the physical square footage
- Make the home feel more spacious
- Enhance the home’s curb appeal
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Refinancing your mortgage to renovate is a popular reason for refinancing and can be a great way to add value to your property. But that’s not the only way to finance a renovation project. Other options like line of credit home loans, home improvement loans and taking out an unsecured personal loan are viable considerations, depending on the changes you’d like to make.
Frequently asked questions
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