What is the best way to get renovation finance when renovating?
One of the Loop Financial Big 6 client questions, this time on renovation finance when renovating.
Ok, so you’ve got a house – perhaps an investment property or your own place – but it’s a bit tired and you want to give it a makeover. The problem is, it’s going to cost a lot and you don’t have renovation finance to fund the project. How do you go about getting renovation finance to pay for your renovations?
Here to explain the process and the different options available is Lauren Mamaj, Finance Stategist and Chief Number Cruncher at Loop.
The first thing to determine, explains Lauren, is whether you’re doing cosmetic or structural work on your property.
“If you just want to give it a bit of a face lift, put in a new stove, do floor boards and painting, that’s what we call a cosmetic renovation,” she says. That’s going to be viewed differently by the bank when it comes to renovation finance to big structural changes, for example knocking down a load-bearing wall.
Getting renovation finance for cosmetic property improvements
If you need a renovation finance for cosmetic renovations, your bank basically wants to know what your property is worth now, how much you want to spend, and how much value that’s going to add. Spoiler alert: if you want to spend $100,000 on work that’s going to add $20,000 of value to the house, your bank is unlikely to take you seriously.
You’ll need to supply quotes for all the work you want to do – either by yourself or through a project manager – fully itemised including materials and labour.
A valuer will go out and have a look at the security, along with the quotes provided, to work out an end valuation for the property after the renovation work has been completed.
You might receive different valuations, for example from your project manager and your valuer.
Imagine you have a $500,000 property and you want $50,000 of renovation finance. Your project manager has given you an end valuation of $570,000 so it seems like a sensible plan. But then the bank sends their valuer in and he calculates the post-renovation value at $560,000. Guess which one the bank is going to base their calculations on? The lower one, of course – “Remember the bank wants to protect the bank,” says Lauren, so they will always go with the more conservative estimate.
Anyway, assuming the project makes financial sense, the bank will then look at your existing equity.
If you’re already stretched to your borrowing limits and need the bank to lend based on the end valuation then you’ll have to go down the route of a construction loan which comes with much stricter controls, says Lauren – more on those later.
But say your property is worth $500,000 in its current state and your mortgage is at $300,000, you’ve got some equity there that you could use to help fund that $50,000 project.
“The bank will still want to know what you’re using the money for, but they’ll be more likely to lend against the existing equity knowing you’re going to add value at the end anyway,” Lauren explains.
There will still be lending criteria for you to meet, because you’re asking to increase your level of debt, but your bank should have a good idea of your ability to service the loan.
Your bank may already be aware of the renovations you plan to do, because when you buy a house, the initial valuation will note any potential improvements that could help raise its value. This could be particularly important for property investors who plan to buy a dilapidated or tired property, give it a facelift, and sell it on for a profit.
“The bank already knows the condition of the property but they still obviously want to make sure that once you’ve completed the renovation, you’ve actually improved the value and saleability,” says Lauren.
Getting renovation finance for structural property renovations
If you’re dreaming of more than just a fresh coat of paint and plan to alter the structure of your house, for example by knocking down walls or adding on extra rooms, you’re going to need a different kind of renovation finance called a construction loan.
This, not surprisingly, requires quite a lot more work up-front from the applicant. You’re essentially changing the security that the bank originally lent on, so they want to do their due diligence and make sure the project will add value.
They also need to know that you’ve planned thoroughly and will be able to complete the renovation – after all, nobody wants to buy a house that’s only half wired and has no roof.
“The bank doesn’t want a poorly costed renovation that’s half finished even though you have spent all the money you borrowed, which then makes the house unsellable or has you asking for more money to finish it, creating other security and LVR issues,” explains Lauren.
So you can expect to be asked for plans, specs, permits, council approval, etc. before the bank will consider your application.
One of the big differences with a construction loan, if you’re borrowing against the end value, is that the bank controls the money at each stage of the project.
“They’ll itemise a payment schedule and work out how they’ll pay the contractors for the project. The first stage might be $20,000 for the flooring, carpets and painting. The bank will send a valuer out to the property to make sure the work’s been completed to the standard that they require,” says Lauren.
The bank will then assess the work and if they’re happy with it they’ll release payment to the contractor as per the payment schedule they’ve approved, then the contractor can continue with the next step of the project.
Things can get even more complicated if you want to complete the construction work yourself.
“It’s harder for us to get owner-builder clients approved for finance as opposed to using a licensed builder for the work,” says Lauren.
The ever-conservative banks will use low financial estimates and put much tighter restrictions on an owner-builder project, making it more difficult to get the project financed.
Finding the right renovation finance provider for your home renovations
So where do Lauren and the team at Loop come into all of this? Lauren explains that their knowledge of different banks and mortgage providers can help take the headache out of finding someone who will fund your renovation given your specific situation and needs.
“It comes down to understanding bank policy and knowing which bank will fund what you’re wanting to achieve. If for instance a client says to me, ‘I just want to do a cosmetic renovation,’ it might work with the bank they are already with and we can move forward.
“If they want to do a structural renovation involving some major improvements, we might have to re-finance them to an alternative bank, because we know it does not fit with their current bank’s policy.”
Lauren will explain all of the different considerations to her clients, making sure they are aware of the various limitations involved with each product and preparing them for the loan application process.
Renovating to add extra accommodation with renovation finance
The cosmetic vs. structural matter is just one of the things your loan provider will ask about in order to determine the kind of finance products you’re eligible for and which one will suit you best.
What if your renovation involves adding self-contained accommodation such as a granny flat, or you plan to turn one building into two as a property investment project?
If this is the route you’re going down, you’re bound to want to know whether the bank will take into account the potential income from the accommodation you’re constructing when working out your ability to repay your loan. Lauren’s answer: It depends.
A market rental assessment from a licensed property manager will give evidence of the rental income potential but you are again at the mercy of the bank’s valuer; if he comes in with a figure below yours, the bank will play it safe and use the lower one in their calculations.
If, on the other hand, you have another investment property for which you already receive rental income, you can provide the bank with lease agreements or rental statements as evidence of your income. That’s assuming it’s all legitimate – if you’ve got a tenant who pays you in cash once a week, you’d probably better keep it to yourself.
If you already own two or more properties, you may be able to raise equity against one property to fund renovations on another, explains Lauren.
“For instance you could raise equity on your owner-occupied property to fund the renovation and once the renovation is complete, you could then apply based on its end value to help repay the debt you have raised against your first property. There are different ways to skin that cat basically, and our job is to make it as seamless as possible for the client but still meet the criteria of the banks.”
Reducing risk with your property renovation
If reality TV renovation shows have taught us anything, it’s that the work never goes quite according to plan. Whether it’s something minor like the wrong colour paint, or something catastrophic like all of your plumbing needing to be redone, it’s important to have contingency plans.
“We have had instances where a client has started a renovation project thinking it would be quite simple and it’s blown up into a full-blown structural renovation, because they’ve opened up an older dwelling and realised, ‘Oh crap, the wiring needs to be done, the sumps are gone and the roof is ready to fall off before long,’ ” says Lauren.
If something major does crop up and you need additional finance to deal with it, will the bank be willing to lend you a bit more or will you have to go down alternative finance routes that come with a much higher price tag? Even if your plan B is to ask mum and dad very nicely to bail you out, at least you have a plan.
Lauren recommends doing your due diligence to identify potential risks before you begin any work. For big construction projects and work involving older houses, it’s a good idea to get a building inspection done on the property – this should bring to light any major structural issues before you start tearing walls down.
You can also talk to an experienced broker about how to structure your property loan and what your contingency options would be in the case of unforseen costs.
And don’t forget the team at Loop are here to help.
“We always tell our clients to talk to us before commencing a renovation project or engaging a builder, so we can best prepare them on what may be needed to move forward and give them a guide on how to proceed,” Lauren concludes.
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