Outgrown your home? The big question is: renovate or relocate?

Part 1 - Renovating


Purchasing a house, especially one you plan to make your home, is an enormous and often emotional decision. For many, it’s something you only do once in your lifetime.


But if you have the means, and your lifestyle has started to outgrow your current property, choosing your next move wisely can be the difference between setting yourself up for greater financial success, and putting your investment into a sinking ship.


If your home no longer suits your needs, the first big decision to make is whether to stay where you are and improve your property, or purchase a new property - either selling your current home or converting it into an investment.


Today we’ll look at the financial elements of renovating - how can you finance a renovation and what factors should you consider before taking a sledgehammer to that living room wall?


Renovation loans


If you’ve decided to stay put and improve your current property, likely you’ll need to finance a renovation. Unless you opt to refinance your home loan in order to fund your renovation, you can apply for finance specifically for the improvement works you’re planning. Lenders will consider this a construction loan, which can encompass everything from a new property built from scratch, to a full demolition and rebuild, to a small extension or reconstruction of parts of the house.


Some of the key factors you need to be aware of when it comes to construction loans are:


The amount you can borrow is calculated based on the estimated property value after the renovation is completed. “On Completion Value” describes the expected value of your home once your renovations have all been finished. Lenders use this value to determine how much you can borrow, in conjunction with other standard factors. Your lender will also consider:

  • Your building contracts

  • Current valuation of your property

  • Extent of the renovations - major structural vs cosmetic

  • Similar properties in the area (to determine comparable value)

  • Standard lending criteria such as your financial position and other assets

Remember: if you have questions about your capacity to borrow as a medical or dental professional, and some of the special requirements or concessions available to you, reach out to the BFD Finance team today.

Construction loans are structured very differently to home loans in how the funds are dispensed. Instead of issuing a lump sum for the full loan amount on settlement, as you would for a home loan, construction loans are generally structured as progressive draw-down payments. At specific stages of construction (such as slab-down, fit-out or completion), your builder issues an invoice and upon approval, your lender releases funds from your loan to the builder as payment. With each payment, you draw-down on the total loan value. Construction loans tend to be interest-only until the loan is fully drawn, which means you generally save on interest, as the lender will only charge interest on the amount of credit that has been drawn - not the full loan amount.

Your lender will be more actively involved in assessing and inspecting the progress of your renovations. A lender may not send an inspector to check out a property you’re looking to buy, but with a construction loan, lenders will in fact inspect the progress of the renovations as part of the process of approving payments to the builder. While this can feel like extra red tape, it can also act as valuable additional reassurance that your property is up to scratch with the proposed works.


Applying for a renovation loan


Applying to fund your renovation has different requirements than getting a home loan to purchase a property.


Firstly, you’ll need to source plans from a reputable and professional builder for the construction you’re intending to carry out. These plans are then presented to your lender, who will appoint a property valuer to assess the plans and determine the On Completion Value. They’ll also determine the amount required to pay the builder, so as to set your loan amount.


In addition to the monetary factors of the renovation, these plans help establish a timeframe and expected completion date in order to schedule payments and build a timeline of works. The plans and blueprints may also include quotations for any additional elements such as materials, specialist installation or services, or landscaping.


Once you receive a loan offer from your lender, as with most other loans you’ll be required to pay a deposit to secure the funds. At each progress payment stage, you’ll sign a draw-down request from your lender to confirm the work has been completed and the payment can be issued.


The risks of renovating


From a financial perspective, one of the biggest risks to consider with renovations is overcapitalising your property. In essence, this means making improvements or upgrades to the house that cost more than the resulting value of the property.


This takes into account both the construction loan you have secured to improve the house, as well as any existing debt you have in the property, such as your mortgage. It also considers comparable homes and average property prices in your area to determine a realistic market value for your home once the works are complete.


For example, if you purchased your house for $650,000, and you currently have $575,000 on your mortgage and have secured a construction loan totalling $250,000, the On Completion Value should be greater than $900,000, or else you run the risk of having over-capitalised the property.


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Many people will have a basic understanding of how a home loan works, but it is crucial to understand that construction loans function very differently and should be considered carefully to ensure improving your property is the best course of action.


In our next article we’ll look at your options if you decide to relocate to a new home. Whether it’s selling your existing property or converting it into an investment, there are many factors to consider.


In the meantime, if you’re a medical or dental professional and you have questions about construction loans, or just want to chat about your options for home financing, reach out to the BFD Finance team today.