Renovation Loans: How to finance your home renovations

Australians love home improvement projects, and a renovation loan could help you create your dream property. We take a look at what’s involved.

Renovating is big business in Australia. In the 12 months to March 2022, Australians spent more than $11 billion on home renovations, according to the Australian Bureau of Statistics.

There’s no doubt, a well-planned, quality renovation can add to your lifestyle – and potentially to your home’s value.

The catch is that home improvements don’t always come cheap. A shortage of skilled tradespeople and rising material costs have seen construction costs jump by 10% over the year to June 2022.

This is not just a cue to carefully plan your renovation budget, it’s also worth thinking about how you will pay for your home improvements.

What is a renovation loan?

There are various possible options for home improvement loans on the market, and finding the most suitable way to finance your next project is a key step in turning your renovation dream into a reality. A renovation loan is a type of finance that lets you complete your home improvement project – and it can range from an extension of your home loan through to a personal loan dedicated to paying for home improvements.

Ways to finance your renovation

But before you decide which type of renovation loan works best for you, it’s worth considering every option. Here are five possible ways to pay for renovations – and some don’t involve taking on debt at all.

1. Offset, redraw or savings: Pay out of your own pocket

To avoid taking on any extra debt, a renovator may decide to use forego a home renovation loan entirely and use funds from a savings account, withdraw money built up in their home loan’s offset account or redraw facility, or sell investments such as shares or property to fund their project.

Using your own money to finance renovations may be more straightforward and potentially be less financially risky than borrowing money. Using this method could also mean you would be free to sit back and enjoy the fruits of your renovation work without having to worry about paying back any extra debt and incurring interest costs.

Let’s look at the options and the points that could be worth keeping in mind:

• Using offset or home loan redraw to fund renovations

Offset accounts and redraw facilities are features of some home loans. It allows the homeowner to put their money into their home loan, or an account linked to it, (over and above home loan repayments) to help reduce the amount of interest payable on that loan.

The extra funds can typically be accessed by the homeowner when needed, according to the lender’s conditions. If you’re considering accessing money via an offset or redraw facility, you may want to check the effect this could have on your loan in the long run. Money saved in an offset facility reduces the interest you’re liable to pay on top of the loan’s principal, so reducing the amount being offset against your home loan could mean you end up paying more overall, and any time shaved off your loan term by the reduction in interest would be lost.

• Using savings to pay for renovations

If you’re planning on using savings to finance your renovations, it may be worth checking whether you’re still left with an ‘emergency fund’ after you’ve withdrawn the amount required for your renovations. Maintaining rainy day savings can potentially help you to deal with any unexpected expenses that could pop up, like an insurance excess or a car service – or even budget blowouts on your renovation project.

• Cashing in investments

Selling investment to pay for a renovation requires careful consideration, as investment markets can fluctuate without warning. There can also be tax implications if selling an investment involves making a capital gain, or profit. It could be a good idea to seek professional advice before making a decision.

2. Refinance your home loan

For those with enough equity built up in their property, refinancing could be an option to consider. Home equity is the difference between the value of your home, and how much you still owe on your mortgage. Refinancing may allow you to leverage your equity to borrow the funds required to complete your renovations.

You could either renegotiate your home loan with your bank to top up the amount of your existing loan (or to obtain a new one), or find another bank that is offering a better interest rate or conditions.

It’s important to note that there can be fees and charges associated with refinancing a home loan, and the extra funds borrowed will impact your loan repayments or the time taken to pay off your loan. And, you would most likely start paying interest on the additional money straight away, even though you may not need it until payments are due across the course of your construction project.

One course of action could be to increase your loan size and place the renovation funds into a 100% offset account (assuming your home loan has an offset facility). This would, generally speaking, prevent you from having to pay any interest on the additional amount until you need to use it.

Another option to consider could be to refinance with a line of credit home loan, which is designed to let you access funds as you need them, with interest charged on the balance owing on your account.

In some respects, refinancing is a similar commitment and process to taking out a new home loan, so make sure you consider the implications it could have on your wider finances and, if you do decide to refinance, shop around for a competitive product.

3. Apply for a construction loan

If you’re embarking on a large renovation project such as an extension or a knock down and rebuild, you could consider a construction loan as tiyr home renovation loan.

Construction loans are typically based on the estimated final (post-renovation) value of your property, which allows you to withdraw whatever amount you need in order to pay the latest renovation-related invoice that has come in. In some cases, construction loans can be interest-only for a period of time, in which case they will generally revert to principal and interest at a future date. This could be in addition to the existing mortgage on your home (known as a second mortgage), or you could refinance your existing home loan to be a construction loan, depending on the lender’s rules and what best suits your needs.

Compare Construction Loans

4. Use a personal loan as a dedicated renovation loan

A personal loan can be a type of renovation loan used to fund home improvements. Personal loans typically allow you to borrow up to a maximum, often around $50,000 though some lenders have higher limits of up to $75,000. If this is sufficient to pay for your renovations, you can generally choose between either a secured or unsecured loan. Interest rates can vary widely depending on the product, the chosen terms, and your credit history.

Secured finance will, generally speaking, be cheaper than unsecured finance. Personal loans are no different for the most part, and typically offer a range of options regarding assets you can secure the loan against, such as term deposits, vehicles, and property.

There are also specific loan options for homeowners considering making environmentally friendly changes to their property such as installing solar panels.

It could be worth bearing in mind that an interest rate which could be considered low for a personal loan product would still be relatively high when compared against a similarly competitive home loan interest rate. With this in mind, you may want to consider the pros and cons of a separate personal loan against refinancing your home loan.

5. Other home renovation loan options

If your renovation is likely to involve smaller, more regular expenses, there are some other types of finance that may be appropriate in place of home improvement loans. For example, you could consider a credit card or overdraft facility attached to your everyday transaction account.

Note that these options typically come with higher interest rates and fees than other types of finance so may not be suitable for all renovations, particularly if you think you might not be able to repay the funds quickly.

It could also be worth looking out for grants or interest-free loans that may be available in your state or local area for certain kinds of renovation work. Some councils in NSW for example offer rebates for homeowners who install rainwater water tanks.

→ Renovating a home could change what insurance cover you may need. Compare home and contents insurance providers.

Inspiration and information: Canstar Renovation Hub

Cover image source: Photographee.eu/Shutterstock.com