Can you include renovation costs in a mortgage?

Traditional real estate advice says to buy the worst house in the best street – you can pay less today and renovate tomorrow. But renovating still costs money, so you may want to look into the options for using your home loan to help take care of your budget.

There are a few different ways you can potentially use a home loan to pay for a renovation, both directly and sometimes indirectly.

If a real estate listing uses phrases like “fixer-upper”, “renovator’s dream” or “bring your builder”, there’s a chance you may not be able to use a regular home loan to buy this property, as its value may not be enough to secure the mortgage. If a property (including vacant land) requires extensive building or renovation work, a special construction loan may be used to pay for it.

Unlike a traditional mortgage, you don’t receive all of the money as a lump sum at the start of a construction loan. Instead, you draw down money in stages as you progress through the project, to pay for each stage of construction. You’ll usually make interest-only repayments on the money drawn down from a construction loan until the work is completed, whereupon the mortgage will revert to a more typical principal and interest home loan.

Keep in mind that a construction loan is typically more involved than other home loans, as your lender will conduct regular valuations throughout the construction project to help ensure the property maintains its value. There may also be other terms and conditions involved, such as having the work carried out by qualified and licensed builders and tradespeople – it’s unlikely you’ll be able to do it yourself as an owner-builder, unless you have the right qualifications, licenses and insurances.

If you’re buying a property or refinancing an existing home loan, you may have the option to borrow a little more than you’d normally need and use this extra cash to pay for renovations.

Keep in mind that getting a bigger loan may require you to hold a bigger deposit or more equity, especially if you want to avoid paying for Lender’s Mortgage Insurance (LMI). Also, a bigger loan means making bigger repayments, costing you more from month to month.

Finally, by paying interest on the cost of your renovation over a term of 20 to 30 years, your project could ultimately end up costing a lot more in the long term than it would by paying for it upfront.

Have you been making extra repayments on your home loan for a few years? If you’re well ahead on your mortgage repayments, there may be a simple way to renovate your property, using your home loan’s redraw facility.  

This mortgage feature lets you take any extra repayments you’ve previously made back out of your home loan again when you need them, such as for last-minute emergencies like medical bills or car repairs, or for projects like renovations.

Keep in mind that redrawing money from your home loan can effectively undo some of the good work you’d done of making the extra repayments in the first place. Extra repayments can help reduce your home loan’s principal, bringing you closer to exiting your loan earlier and shrinking your interest charges. Using this money for renovations may mean your loan takes longer to repay, costing you more in interest charges over the long term.

The current value of your home, minus the amount still owing on your mortgage, is called your equity. If you’ve been making regular mortgage repayments (including extra repayments) for a few years, and your property has increased in value since you bought it, you may have more equity available in your property than you realise.

Equity can be used for a range of purposes, including securing access to credit. A line of credit may let you borrow money against the value of your home equity, including spending on renovation projects.

A line of credit works a lot like credit card, except the maximum credit limit is effectively your home equity, so you can usually borrow more money. Much like a credit card, you’ll only be charged interest on the money you borrow, and the repayments are flexible. This can be handy if you plan to renovate a property over a longer period and pay off each stage of the project one at a time.

Of course, much like a credit card, it’s important to keep an eye on those interest charges, and avoid letting them build up to a point where you can no longer comfortably afford to pay off your debt.

Another potential use for your home equity is to secure a personal loan, separate from your home loan. Secured personal loans often have lower interest rates than unsecured personal loans, and because they typically have shorter loan terms than home loans (often anywhere from 12 months to 10 years), you may pay less total interest on the cost of your renovations.

However, there are risks involved. Chiefly, if you default on personal your loan, this could mean losing your security – in this case, your house. Additionally, personal loans often have higher interest rates than most home loans.