Best options for paying for your home renovation

Renovating your home or investment property can add some serious value to its overall worth and improve the way to live in and use the property.

According to Finder research conducted in the first quarter of 2021, almost half of all Aussies can afford to fund a renovation out of their savings, but the remaining 53% need to access some sort of lending. If you fall into the second category, we're here to shine a light on the most effective ways to pay for your upgrades.

Reno option no.1: Home loan top-up

A home loan top-up is a way of tapping into the equity you have in your home. You can approach your lender and ask them to revalue the property, with the hope that they will value the property at a higher amount.

For instance, let's say you purchased a home for $800,000 five years ago with a loan of $720,000. You've made some headway with the loan, so it's now paid down to $690,000. You request a current valuation from the lender, and it comes up at $900,000.

Your current situation is as follows:

• House worth $900,000
• Loan of $690,000
• Loan to value ratio (LVR) of 76.6%

You can draw out cash from your loan to fund your renovation. Banks will generally lend you up to 80% LVR without charging you lenders mortgage interest (LMI). In this example, 80% LVR of the new value is $720,000.

This means you can borrow $30,000 – the difference between your current loan and the maximum 80% LVR. If you wish to borrow more than this, you'll pay LMI.

Benefits

• It's a low-interest option for funding a renovation.
• A home loan top-up is a fairly simple process and can be processed quite quickly.
• You won't have to apply for an entirely new loan.
• You will only have one single home loan and repayment to worry about, as you're taking on a separate debt for the renovation.
• If you've built up a lot of equity, you could be able to draw out a significant cash amount.

Drawbacks

• You'll be adding to your original debt, meaning it could take you longer to pay off your home loan overall.
• You'll pay more interest in the long run.
• Your repayments will rise, so you'll need to budget to make sure you can afford your new repayment amount.

Learn more about refinance home loans

Reno option no.2: Loan top-up based on future value

You may be able to share your renovation plans with your lender, with a view to persuading them that your upgrade will add to your property's value.

Going back to our earlier example: your property is worth $900,000, and you have plans to install a new kitchen and add a covered patio. The total investment is $60,000. You request a valuation from the lender based on the home being renovated as per your plans, and they estimate your renovation would add around $80,000 to the value of your home.

Your current situation is as follows:

• House worth $900,000
• Loan of $690,000
• Projected value post-reno $980,000
• Potential loan based on 80% LVR: $784,000

You can draw out cash from your loan to fund your renovation. In this example, you can borrow up to $94,000 to fund your renovation without being charged LMI. You only need around $60,000, so you top up the loan to this value.

With this type of loan, also known as a construction loan, rather than paying out a sum of money all at once, the bank will generally make money available in instalments as the renovation progresses. They may need to see invoices from builders and contractors in order to release the next "draw down" of funds.

Benefits

• It's a low-interest option for funding a renovation.
• The application process is fairly simple and can be processed quite quickly.
• You won't have to apply for an entirely new loan.
• You will only have one single home loan and repayment to worry about as you're taking on a separate debt for the renovation.
• If you've built up a lot of equity, you could be able to draw out a significant cash amount.

Drawbacks

• You'll be adding to your original debt, meaning it could take you longer to pay off your home loan overall.
• Drawing down the funds can be a little more fiddly and requires ongoing communication between you, your contractors and the bank.
• You'll pay more interest in the long run.
• Your repayments will rise, so you'll need to budget to make sure you can afford your new repayment amount.

Finder survey: Why did Australians refinance their home loan?

Reno option no.3: Refinancing to a new loan

Switching to a more competitive, lower-rate mortgage can be a really smart way to fund your renovation and save you money on unnecessary extra mortgage interest at the same time.

Refinancing could help you unlock the cash you need with a reasonable interest rate, and if you haven't looked at your home loan for a while, you may be surprised at how much you could save with a better deal.

To refinance to fund your home renovation, start by looking at your current home loan rate and comparing it against other products on the market.

Find a similar mortgage with a lower rate and features that suit your needs (such as an offset account) and use a borrowing power calculator to get an understanding of how much you can borrow, and what your repayments would be like with a higher mortgage. Then apply for your new loan. Once approved, your new lender will help you with the process of leaving your old lender.

Benefits:

• It's a low-interest option for funding a renovation.
• You could end up saving money on your mortgage, if you refinance to a lower rate.
• You may benefit from a home loan cashback offer, usually between $1,000 and $4,000, to boost your renovation budget.

Drawbacks:

• Refinancing requires a new mortgage application and this can take an average of 30 days, sometimes even longer during busy periods.
• Refinancing can come with exit or switching fees from your old loan (especially if you have to break a fixed rate) and fees for the new loan.
• Your new loan may default to a 30-year loan term, making it even longer until you own your home outright.
• If you don't have much equity or the value of your property has fallen, then refinancing might be more challenging or could even cost you lenders mortgage insurance if your LVR rises above 80%.

Reno option no.4: Line of credit home loan

A line of credit loan uses the equity in your home to extend a credit limit to you that you can use for any purpose, including renovating, buying a car or going on holidays – the choice is yours!

Equity is the difference between what you owe on your home and its current value. For instance, if you owe $500,000 on your home loan and your home is valued at $750,000, you've built up $250,000 in equity.

A line of credit loan allows you to tap into this equity. Your lender will offer you a credit limit based on your equity, and you can use as much or as little as you like. Think of it like a giant credit card facility attached to your home loan, only every dollar you spend adds a dollar of debt to your home loan.

Benefits

• A line of credit loan offers a huge amount of flexibility since once approved, you can use as much or as little of your credit limit as you need.
• You'll only be charged interest on the amount you've actually used for your renovation project.

Drawbacks

• These loan products usually come with a higher interest rate than standard home loans.
• It can also be difficult to manage a line of credit home loan. You'll have to budget well to keep your project within your credit limit. Since you have easy access to the funds, it's very easy to overspend.
• These loans can come with tougher loan criteria, which can make it harder to gain approval.
• Your repayments will rise based on how much money you access, so you'll need to make sure you can afford your new repayment amount.

Reno option no.5: Personal loans for renovations

If none of the above mortgage options work for you, then perhaps a personal loan is the way forward.

Finder research reveals that around 17% of Australians would consider using a personal loan to pay to bring their renovation plans to life, and a further 4% would use a credit card. A credit card should be your absolute last resort, as the high interest rates can add a hefty premium to the total renovation cost.

However, a personal loan may be a reasonable option if your renovation is small and won't require a significant expenditure.

Benefits

• Personal loans are often processed quickly, so you could have the funds in your account shortly after applying.
• If you're borrowing a small amount, they can be a fast, convenient way to fund your renovation.

Drawbacks

• Personal loans often carry high interest rates, especially unsecured loans – definitely much more than you'd pay in mortgage interest rates. Rates can vary significantly from one lender to the next, so it's crucial to compare your options.
• You'll have to manage two repayments each month: your home loan and your personal loan.
• The payments need to be spread out over a maximum of seven years with a personal loan, so with higher interest rates and a shorter repayment term, this is the more expensive option when compared to funding the renovation via a mortgage.

Learn more about personal loans for home renovations

Written by

Sarah Megginson

Head of editorial

As an authority on all things personal finance, Sarah Megginson is passionate about helping you save money and make money. She is an editor and money expert with 20 years’ experience and an extensive background in property and finance journalism. Sarah holds ASIC RG146-compliant Tier 1 Generic Knowledge certification, and she's a regular media commentator, appearing weekly on TV (Sunrise, Channel 7 news, Nine news), radio (KIIS FM, Triple M, 3AW, 2GB, 6PR) and in digital and print media. See full bio

Sarah's expertise

Sarah has written 183 Finder guides across topics including:

• Home loans
• Personal finance
• Budgeting and money-saving tips
• Managing the cost of living