Home loan vs. renovation loan: here's why the difference matters.
If you’re interested in a renovation loan, chances are you already have a home loan. So can’t you just use that for renovating? You can, but a home loan and renovation loan aren’t quite the same. Let’s look at how they work so, when comparing home loan and renovation loan options, you understand the choices to make.
A home loan is, unsurprisingly, a loan to buy a home. In return for the money, you give your lender security over the property you are using the loan to buy. Home loans will typically be on a 25 to 30-year term, with regular fortnightly or monthly repayments.
If you have enough equity built up in your home, you can refinance your home loan – essentially borrowing more money against the increased value of your home. This can include borrowing money to fund a renovation. Doing this will increase the amount of your total loan that needs to be repaid. This gives you longer to repay the additional finance as it will be spread across the life of the loan, but it will likely cost you more in loan repayments.
What to look for in a renovation loan
A renovation loan is a great choice if you don’t have enough equity in your property to borrow or have the ability to repay your loan quickly. The amount you can borrow is based on the estimated post-renovation value of your home.
If you’re wondering what renovations are eligible, you simply need to consider: will it improve your home value? Compared to extending a home loan, a renovation loan will likely save you money, because it can be paid off completely within a shorter amount of time.
Renovation loans, just like any other personal loan, have the same building blocks. Understanding those pieces will help you choose the right loan for you.
When you borrow money from a lender, you agree to pay it back with interest. The percentage of interest that you’ll pay on top of the amount you borrow is called the Annual Percentage Rate (APR) or Advertised Rate. It’s usually an annual rate. To work out your rate, lenders will factor in things like your credit history, your repayment schedule, the risk of lending to you (both personally and looking at the market) and their underlying costs.
The lowest rate lenders have available is the headline advertised rate. But it’s usually only available to a small proportion of borrowers. It may come with set conditions to qualify (e.g. a high credit rating) so you might not be offered this rate.
What you’ll likely need is a personalised rate. Talk to a number of providers and see what they’re willing to offer you. Just check that their quote process is ‘credit score friendly’. You want to make sure they only conduct a soft check on your credit file, so it won’t impact your credit score.
And remember, it’s important to consider the total cost of the loan including interest, fees and other costs to properly assess the value of any interest rate on offer. Because the best loan for you might not actually come with the lowest interest rate.
As well as interest, a renovation loan will usually come with fees and other charges. They can quickly add up, and suddenly the great rate you get isn’t worth it. A comparison rate factors in the interest rate and any fees expressed as an annual percentage. The comparison rate is usually higher than the interest rate charged on the loan and gives you a better idea of how much the loan will cost you.
It’s a pretty important number, which is why lenders and brokers must provide a comparison rate when they advertise a loan interest rate under the National Consumer Credit Protection Regulations.
How is it measured?
For renovation loans, there is a standardised measure for how comparison rates must be calculated and displayed. For variable and fixed-rate personal loans, the comparison rate is based on a $30,000 unsecured loan over 5 years.
But don’t get caught out – not all costs are included. You should remember you still need to factor in:
- Late payment fees
- Break costs or early termination fees
- Deferred establishment fees
- Broker fees (when taking out a loan through a broker, the broker’s service fees aren’t included in the comparison rate, which can be significant)
When it comes time to pay back your loan, you’ll be making regularly scheduled repayments, either weekly, fortnightly or monthly. When you factor these repayments into your budget, check that your loan repayment calculations have been quoted inclusive of any ongoing fees.
Your lenders might also give you the option of making a lump sum repayment at the end of the loan term, called a balloon payment. It’s a handy way to manage your cash flow, because it reduces your regular repayments. But you’ll be paying interest on a higher loan balance as you go. However, the lump sum is still due at the end of the loan, so you’ll need to remember to find the money along the way.
When you apply for a loan, you’ll face a few one-time charges to establish the loan. Known as establishment or application fees, they can include:
- A flat fee (e.g. $499) that applies regardless of the value of the loan
- A tiered fee (e.g. $250, $500, $750) based on the value of the loan
- A percentage fee (e.g. 3%) based on the total amount borrowed and the credit or risk profile of the customer
- A hybrid fee (e.g. $200 + 2% of the loan amount)
It’s up to your lender if they charge any or all of these
But even though they’re called ‘up front’ fees, that’s only when you’re charged them, not when you pay them. They’re usually capitalised to the loan, meaning they’re added to your loan, increasing your total loan amount.
That means you’ll be paying interest on those fees (as part of your total loan) for the life of your loan. If it’s a small upfront fee, the difference might be only a few dollars on each repayment. But if they’re significant, they can be costly.
Monthly or ongoing fees
Ongoing, account keeping or loan management fees, are typically paid monthly across the life of a loan. They just go straight to the lender and don’t help you pay down your loan at all. Typically, the lower the fees, the better. But it’s still important to look at the total amount you repay when you factor in all interest payable and costs.
Brokers can be helpful, but you’ll still need to pay them for their service, whether or not you realise it. For personal loans, the brokerage fee is often capitalised to the loan amount and is additional to the lender's own upfront fee. Brokers can also have commission arrangements with lenders built into your interest rate or offered as a return based on the final rate you accept. It’s another cost you should remember.
Penalty fees are avoidable, but they’re still a reality. The most common penalty fee is the ‘default’ or missed payment fee. If you make a payment late, or there are insufficient funds in your nominated account on the day a payment is due, you’ll likely be hit with a fee.
Late fees vary from $10 to as much as $35. Your lender may waive the fee if your account is brought up to date within 3 days of a missed payment, but you shouldn’t count on it. Be sure to keep an eye on your spending and make sure you have enough in your account to pay the loan. You might even like to set up a separate account dedicated to paying your loan.
Early repayment fees
Paying back your loan early is a great way to save money, just make sure you don’t get charged a hefty early repayment fee that undoes all your good work.
Exit fees or early repayment fees are more common with secured low-rate loans. There are different types:
- A fixed fee where the loan is repaid in full any time prior to the end of the loan term (e.g. $500)
- A fixed fee where the loan is repaid in full prior to a minimum period (e.g. $250 if full repayment is made less than 2 years into a 5-year loan)
- A variable fee based on the amount you would have paid in interest and fees had the loan run to full term
How much money do you need for your renovation? Yep, that’s your loan amount (plus those upfront fees). This is the principal part of your loan that you’ll be repaying. Interest is charged on top of this, based on the outstanding balance of your loan.
In Australia, renovation loans usually range from $2,000 to $50,000, but some lenders will go higher.
A renovation loan gives you a dedicated window to pay back what you borrowed. In Australia, lenders offer loan terms between 1 and 7 years, with 3, 5 and 7 year terms being the most common.
Your monthly repayments will be lower if you take longer to pay. Just remember, to do your sums because a longer-term loan might have a higher interest rate that will cost you more overall.
A variable fee based on the amount you would have paid in interest and fees had the loan run to full term
Finding a lender that cares is the glue that sticks it all together. Look for a lender who makes it quick and easy to apply, get approved and manage your loan. They should care about your experience. If you know they care, you can more easily trust that you’re getting a great deal.
What can I use my renovation loan for?
For a kitchen renovation fit for a master chef or simply to fit more friends at the table – it’s your choice.
Looking to add value to your property, expand your living space, improve your home’s energy efficiency, or simply to make it a more comfortable place to live? You can do it all and more with a renovation loan. That dream kitchen renovation? Done. That extra room downstairs? Move right in. If you can dream it, you can build it. A home renovation loan can help you pay for it.
For home, sweet home
Turn those home dreams into home pride. A renovation loan can be used for:
- Kitchen renovations – A renovation loan can be used for any kind of kitchen renovation or remodel, including cosmetic renovations such as installing new appliances and furniture. Add more cabinets, remodel to suit your lifestyle or instal new splashbacks that pop, it’s for everything including the kitchen sink
- Bathroom renovations – A renovation loan can take your bathroom from “oh dear” to “oh my.” Update an old bathroom from top to bottom – upgrade taps and plumbing, install a new shower or bath and replace those outdated tiles with your designer choice. You can also add a second toilet or bathroom
- Bedroom renovations – A renovation loan is perfect when a bedroom needs a quick lift. Bedroom renovations can include new paint and cabinetry, new beds, curtains as well as updated flooring such as carpet, floorboards or tiling
- Living area renovations – A renovation loan can help you gain that much-needed space, extending your living area for more comfortable family gatherings
- Backyard renovations – Renovation loans aren’t just for the inside. You can also use them to pay for outdoor improvements that make life outside more enjoyable, like a new garden, those long overdue pavers, a retaining wall, a deck or a pool
- For adding value — It’s not all about what you get now, a renovation loan can also help you plan for the future. Renovation loans can be used to fund any value-adding renovations. These types of renovations include adding an addition to your house which can boost your property’s overall value and comfort.
For going green
A renovation loan can be used to not just improve your life but improve the planet. Cover the costs of green or energy-efficient additions to improve your home’s sustainability, such as solar panels and insulation. And you might just end up helping your hip pocket.
For feeling secure
Take care of everything that’s precious to you and use a renovation loan to make your home more secure. You can use it for security screens, a garage or secured parking.