What types of renovation loans are there?

Looking for a home loan with money for renovation? You might want to think of a personal loan instead.

Often your dream home doesn’t start out that way. If you’ve got a project waiting, or you’re considering buying a renovator’s delight, you might be looking for a home loan with money for renovation. Sometimes that’s possible, but it depends on your circumstances. And you might find that a stand-alone renovation loan is a better choice. Let’s look at what’s available.

Isn’t that what my mortgage is for?
If you’re looking for a home loan with money for renovation you’ll need to tap into the equity in your home. You’re essentially refinancing your home and increasing your loan amount to fund your home improvements. But there’s a catch. A few of them, actually.

First of all, you need to think about your loan to value ratio (LVR) – how much is your house worth compared to how much you still owe? If you have a high LVR (where you still owe most of its value) you won’t have the equity available.

Secondly, by rolling your renovations costs into your home loan, you now have a bigger mortgage. You’ll be repaying these borrowings for the life of the loan – that could be up to 30 years. What might seem like just a small difference to your repayments now can add up over time, costing you more in the long run.

You also might not be in the position yet to extend your home loan. If you’re looking to buy a new house, you’ll find that home loans generally don’t include renovation costs. So you’ll need to look elsewhere.

A more personal choice
Rather than mess about with your mortgage, you might like to consider a renovation loan. A renovation loan is simply a personal loan you’re using to fund your renovation costs. And they come with a few choices.

Secured or unsecured?
You can choose to secure your loan against something of value that you own, like a car, home or term deposit. It’s less risky for a lender to loan you money so you can usually access a lower interest rate. You may also be able to borrow a larger amount and get a longer loan term. But on the flipside, you give your lender the right to seize your asset if you fail to make repayments.

However, most personal loans are unsecured, with no assets used as security against the loan. A lender will choose to loan you money based on how creditworthy you are. It’s more of a risk for them, as they have no guarantee.They’ll only be looking at whether or not they think you’ll be able to pay money back. 

Because of this, you’ll probably be offered a higher interest rate, lower loan amount or a shorter term. But the application and approval process are usually quicker, you’ll have more freedom to use the funds and your assets aren’t directly at risk if you default.

Why choose a secured loan?
+  Lower rates
+  Increased borrowing potential
+  Longer terms available
-  Can take longer to approve
-  Your asset is at risk if you fail to pay

Why choose an unsecured loan?
+  Greater freedom
+  Quick application process
-  Higher rates
-  Less borrowing potential
-  Shorter loan terms

Keeping your interest rate fixed or variable
You can also choose what type of interest you’d like to pay, either at a fixed rate or variable.

If you choose to fix your interest at a rate, you can be confident that it will remain the same for the life of your loan. You’ll usually be offered a higher interest rate than for variable-rate loans, but if variable rates go up, you’re protected.

With a variable rate loan, your interest will move up and down with the market. So if the market interest rate goes down, so will your repayments. But, if they go up, you’ll be paying more.

Remember that you may have less flexibility to make early repayments with a fixed rate. But many online loan providers offer no early repayment fees, regardless of whether your loan is fixed or variable. Be sure to check with your lender first.

Why choose a variable-rate loan?
+  Usually more flexibility to repay your loan early
+  You’ll benefit from lower repayments if interest rates go down
+  Rates are competitive
-  A rate increase will result in higher repayments
-  Budgeting is harder

Why choose a fixed-rate loan?
+  Know what your repayments will be for the life of the loan
+  Easier to budget
-  More likely to have early repayment fees
-  May be less flexible depending on provider

Anything else to know?
When you’re thinking about all things loan, there are a few other terms you probably want to be familiar with.

Fixed-term vs line of credit
A fixed-term loan is a traditional kind of loan – you get the money as a lump sum and then pay it off within the agreed time period. You make regular repayments and know exactly how long it will take you to pay back your loan. 

A line of credit is a bit different as it works more like a credit card. It’s up to you when you draw on the funds from your ongoing credit facility – you access the money when you need it. You then pay off the debt (including interest) in instalments. The bonus, of course, is that you only pay interest on the money that you’ve actually used, not the whole loan amount.

Special or limited purpose loans
If you’re using the loan for a specific purpose, you may be able to access personal loans with lower interest rates from some lenders.

Risk-based pricing
With the introduction of comprehensive credit reporting (CCR), credit providers now must include extra ‘positive’ information in your credit report, such as the type of credit you hold, the amount of credit and whether you pay your bills on time. Previously, credit reports didn’t give the complete picture – they only showed the ‘black marks’ or negative credit events (such as missed payments or defaults). 

That means risk-based pricing has become more common. Most lenders now tailor the loans offered to you and give you a ‘personalised’ interest rate. They’ll look at your credit history, financial situation, the loan type, the loan amount and a range of other factors to build your unique risk profile. The rate you get is based on the probability (or risk) of you defaulting on your loan.

If you’re considered more likely to pay back the loan, you’re ‘lower risk’ and you’ll be rewarded with a lower rate. But expect to get a higher rate if you’re ‘higher risk’.

The right loan for you
Feeling a bit spoiled for choice? Keep it simple. Ask yourself:

  • What’s the interest rate like? Before choosing your loan type, you should compare renovation loan rates to find the lowest possible rate available 
  • Do you prefer a fixed or variable rate? 
  • Can you realistically make repayments on time? 
  • What is the length of the loan?

Don’t forget to factor in any fees and charges. Answering these questions can go a long way toward making the decision for you – whether you need a home loan with money for renovation or a tailored personal loan.

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