Before going ahead and taking out any loan for your renovations, you might want to first assess the different types of home renovation loans.
Different home renovation loans can benefit different things, and utilising the right one can save you time, effort, and money.
For a practical idea of which loan will be best for which types of home improvements, you can access our guide on how renovation loans work.
However, if you want to know what the different home renovation loans entail, here’s what you need to know.
Which Types of Loans Can You Use For Home Renovations?
- Construction loan
- Personal loan
- Top up your existing loan
- Offset account/redraw facility
When to Use a Construction Loan
Construction loans can be used if you’re building a whole new property or undertaking major renovations on an existing property.
These home loans are structured according to a progressive drawdown.
So, Instead of receiving the lump sum of your home loan upfront, you receive increments at each milestone of the construction process to fund them.
The progress payments work according to the following milestones:
- Slab down or base: laying the foundation.
- Frame stage: building trusses, brickwork, roofing and window frames.
- Lockup: external walls, putting in doors and windows.
- Fitting/fixing: plumbing, electricity, gutters, cupboards, benches.
- Completion: final payment for builders and equipment.
With construction loans, interest is only charged on the amount of money that has been released.
If by the “lockup” stage (when the builder puts up the external walls and puts in the windows and doors) you have already used $200,000 of your $300,000 loan, you will be charged interest on the $200,000. So just be sure to budget for it to increase with every instalment.
How Does a Personal Loan Work for Home Renovations?
Personal loans are divided into two different types, including:
- secured personal loans, and
- unsecured personal loans.
Secured Personal Loan
Secured personal loans require an asset as a means of security if you default on your repayments. This could be something like a car, and if needed, your lender can sell your asset to cover the losses.
This security means that secured personal loans often have lower interest rates than unsecured personal loans.
Unsecured Personal Loan
An unsecured personal loan is a higher risk to the lender, as there is no asset attached as security. For this reason, the interest rates are typically higher than secured personal loans.
Personal Loan Repayments and Interest Rates
The interest rate of a personal loan can either be fixed or variable:
- Fixed interest rates: personal loans with a fixed rate do not fluctuate. So, the interest rate is fixed for the life of your loan, and your monthly repayments will remain the same, regardless of whether the market rate goes up or down.
- Variable interest rates: personal loans with a variable interest rate structure will fluctuate over the life of your loan according to how the markets go up or down. A variable-rate structure also offers key features such as an offset account or redraw facility, which can also be used to complete home renovations (discussed below).
So, when choosing a personal loan to fund your home renovations, keep in mind that you can choose between a fixed or variable interest rate.
Secured loans will have lower interest rates than an unsecured loan because you’re securing an asset against the personal loan (or, in this case, a personal renovation loan).
How Can You Use Your Existing Home Loan?
You can add an extra amount of money to your existing home loan and use it to fund your home renovations. This way, you keep all your repayments in one place.
You’ll be eligible to do this if you have a variable interest rate home loan. If it’s fixed, you’ll have to break your agreement, resulting in extra fees and charges.
Adding an amount to your current loan will increase your monthly repayments. This is because it doesn’t affect the loan term timeframe. If you still have 25 years to pay off your home loan and decide to increase your home loan amount by topping it up, the required time to repay the loan will remain.
A benefit of doing it this way instead of taking out a personal loan is that home loans generally have a lower interest rate. So you can borrow the same amount of money, but pay less in total.
How Does a Home Equity Loan Work?
Refinancing your home allows you to access its equity, and you can use this money to fund your home renovations.
There will be enough equity to refinance when you have paid off at least 20% of your home loan and your property has increased in value.
So, you’ll need to have your property evaluated to determine how much equity you can access for your renovation loan.
Your property’s equity is calculated by deducting how much you still have outstanding on your home loan balance from your property’s new market value.
Suppose you buy a house for $600,000 and pay a $100,000 deposit. If that’s the case you would have taken a home loan out for $500,000.
If the loan term is 25 years and you’re paying the principal and interest at a rate if 3% per annum, your loan repayments will be around $2,300.
So, after ten years , you would’ve paid around $158,000 towards your mortgage.
In those ten years, the house’s value has increased to $650,000.
To work out the equity, you would subtract the amount you still owe on your home loan ($342,000) from the home’s new market value ($650,000.) So, in this example, the home’s equity is $308,000.
You will be able to access up to 80% of your property’s valuation if you’ve been up to date with your mortgage payments over the life of the loan and have a good credit history.
So, you’d be able to access up to $178,000 of your home equity to fund your renovations.
How to Utilise Your Offset Account or Redraw Facility
When you set up your home loan, you may have access to certain features. Home loans with a variable interest rate offer the following features:
- Offset account: if you deposit lump sums or make extra repayments on your monthly mortgage, this money can be collected in an offset account. The extra payments are offset against your outstanding loan amount every month, and you’re only charged interest on the difference.
- Redraw facility: if you have made additional repayments into your home loan over and above your monthly mortgage, you can redraw that excess money.
So, if you buy a house and know that a few years down the track, you will embark on a renovation project that you want to save money towards, you can set up your home loan with either of these features.
Putting extra money into your home loan typically requires a variable rate loan, as fixed interest rates don’t allow for extra payments to be made (or up to a certain amount only.)
How The Mortgage Agency Can Help With Your Home Renovation Loan
A home renovation project doesn’t always require a renovation loan.
While you can take out a construction loan, a personal loan, or top up your current home loan, you could also use money that you already have from an offset account or redraw facility.
Or, you could use money from the equity of your home.
How you fund your home improvements is based on your financial situation, personal objectives, and current home loan.
Mortgage brokers are home loan specialists, and they can help you assess these factors and suggest the best strategy appropriate to your personal circumstances and future renovation considerations.
At The Mortgage Agency, we seek to understand our customers and provide them with a solid grasp of the fundamentals of home loans. So, if you need help reviewing your existing loan arrangements for a more viable option to take out a new loan for your home renovations, get in touch with us today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.