Renovating

Here are the 4 essential elements to building & renovating property

Are you considering Building a new home or upgrading your existing home? Here at The Home Loan Guy we are about helping you to make informed decisions. So, let’s sit down and chat through some of your questions.

Firstly, if we look at building a home clearly you are starting from a bit of dirt or maybe knocking down an old house to rebuild, I think easy to understand what I am referring to.

The Renovations we are talking about here are what the Lenders call “structural” renovations, things like moving walls or adding rooms and extensions etc. It is important to note lenders can have a different definition so let’s agree for the moment we are looking at a significant renovation.

  • If you are looking to renovate your bathroom or kitchen these are simpler, and you can look at the refinance section or at this page on cash out for renovations.

What Documentation do you need?

In addition to normal lender requirement like bank statement, pay slips etc there are 3 main documents required that are special to construction loans.

1. DA Approved plans:
What we are talking about here are plan your architect or builder has prepared, these will be submitted to council as part of your Development Application (called a DA). When this is approved council will stamp these plans with an “approved” stamp showing that they are the final approved version of the plans.
2. Building Contract
Your builder will prepare a contract (commonly on a Housing Industry Australia (HIA) format) that will detail cost of the build and importantly detail the progress payment schedule.
3. Building Specifications
This is a document detailing the quality of the finishes you are putting in the house, from light switches to tiles and flooring. From the kitchen sink, tap and vanity. All these things make a difference to the quality of your house you are building and we need to make sure the valuer understands.
4. On Completion Valuation
This is something the bank will organise once they have the above 2 documents, but it is something special to Building Loans and is slightly different to a normal valuation.

How Much Can I Borrow?

What’s the most important part of the building and renovating process?

No, it’s not the building plan or the development application. It’s the finance.

Just like when you’re buying a new home, the key step is to figure out how much you can borrow. Once you’ve done that, you’ll know how much you can spend on building a new home or renovating your existing home.

As your broker, I’ll help you get to the bottom of four key issues:

  • Borrowing Power – How much money will the bank lend you?
  • Capacity – How much debt are you comfortable carrying?
  • Contribution – How much money do you need to contribute? How much equity can you
    access?
  • Purchasing power – How much money can you spend on the build / renovation?

Once we have worked through these four elements, you will be able to make an informed decision about whether it is possible to build or renovate – and, if so, what sort of project you want to tackle.

Borrowing Power

1

CAPACITY

2

Contribution

3

Purchasing Power

4

Your borrowing power is unique to you.

It is based on your income, employment situation, assets, liabilities and spending habits, as well as the characteristics of your current home and/or the new home you’re planning to build.

So don’t pay too much attention to whatever amount of money a friend or colleague was able to borrow – because their situation will be different to yours. They may have more credit cards they don’t tell you about or they may simply be comfortable borrowing more tan you. You might also be surprised to learn that borrowing capacity can vary significantly from lender to lender. For example, while Bank A might be willing to lend you $590,000, Bank B might be willing to lend you $630,000.

As an experienced broker who works with a diverse array of lenders, I’ll know which lender is most suitable for you, based on your unique financial position.

Want to get started on your property investment journey? Book an appointment.

“How much will the bank lend me?” is a vital question. “How much debt do I feel comfortable with?” is a completely separate one.

Before taking out a loan, you need to calculate your capacity to repay that loan – month after month, year after year and it is not just about paying the minimum repayments, you need to consider how much extra can you pay, especially when interest rates are so low.

To calculate your capacity, you need to see how much of a ‘gap’ there is between all the money coming into your bank account (salary, dividends and any other income) and all the money going out (mortgage repayments, council rates, school fees, petrol, groceries, holidays, etc).

Your income may change significantly if one member of your household gets a promotion, switches career, stops work to have a baby, returns to work after having a baby or starts a business.

Your expenses may change significantly if you start paying childcare or school fees, stop paying childcare or school fees, change your holidaying habits, sell a car or upgrade a car.

You also need to think about your risk appetite. If you’re confident about the future, you may feel comfortable with a relatively large mortgage (compared to your household income). If you need more security to help you sleep at night, you might prefer a smaller mortgage.

So, there is no right or wrong answer to the question “How much debt do I feel comfortable with?”
It, all depends on your unique circumstances.

‘Deposit’ can be a confusing word because it can mean two different things. First, you will need to pay a 10% deposit as part of the Contract. Next, a lender will expect you to have a deposit before as part of getting a loan.

It is your total contribution that we ate looking at here and it can be made up of different things:

  • Savings
  • Family gift
  • Family equity guarantee
  • Government grants

Whether you want to take out a loan for a renovation project or a new build, the lender will expect you to make some sort of contribution.

A 20% contribution is typical, although you could contribute just 10% if you were willing to pay lender’s mortgage insurance.

One way to pay that contribution is through cash savings. Another is to borrow against the equity in your current home, and use that new loan as your contribution.

Savings:

The simplest way to fund your contribution is to dip into your savings, because you have instant and guaranteed access to the money.

However, you might not have enough savings to fund your contribution. Or you might have enough savings, but prefer to leave that money untouched so it’s on call for some other use in the future. In that case, if you’re a homeowner, you might be able to tap into the equity of your current home.

Borrow against your equity:

Equity is essentially how much of the home you own (as opposed to how much the lender owns). Let’s say, your home was valued at $850,000 and you had $500,000 left on your mortgage, your equity would be $350,000.

We have talked in detail above about how banks value a property and how this may be relevant to you and how it can impact what you are trying to achieve.

If you want to tap into your equity, lenders will generally allow you to borrow 80% of the property’s value minus the outstanding mortgage. In this example, your available equity would be $180,000:

It is possible to borrow more than 80% of the value of a property, but as soon as you do you will pay Lenders Mortgage Insurance (also called LMI).

When building we do need to be careful to understand each lenders policy on LMI loans with construction to make sure it is possible and we pick the right option. Each leader will have different LMI fees and different interest rates, so we need to take time to make informed decisions.

Once you know how much you can borrow, how much you feel comfortable borrowing, how much of a contribution you’d make to your loan and how you’d pay it, you’re ready to calculate your purchasing power.

Purchasing power refers to the maximum amount you could spend (and would be willing to spend) on the land and building your new home. It may not quite be the right word when you are renovating your existing property, but hopefully you get the point.

It’s the final figure and includes all associated costs to give the full picture of that is possible.

For example, when you renovate, you’re not just paying for construction labour and materials. There are other costs, such as hiring an architect, lodging a development application, and applying for a loan.

When you build, you might have all those costs plus stamp duty, conveyancing, and valuation.

Once we have worked through all four pieces of the puzzle, we can start talking about lender options and finding a loan and lender suited to your unique circumstances, and then apply for a pre-approval on your behalf.

Ready to start planning your renovation or construction project?

(* If you buy a property in a strata complex, you need a strata report. If you buy any other type of property, you need a pest and building report.)

Imagine this was your situation – that you had a home purchase price of $500,000. You would then need to ask yourself what sort of property you could buy for $500,000. You might need to refine the number.

You might conclude $500,000 is too low, because you want to buy a better (i.e. more expensive) property. Or you might conclude it’s too high, because you’d struggle to make the mortgage repayments on a $450,000 loan.

Don’t be discouraged, because you’re not locked into your initial purchasing power number. Now we’ve got somewhere to start, we can work on it together, and move it up or down, depending on your situation.

This is an important process to follow. Once it all comes together, you will feel confident about your financial position and ready to buy your first home.

FREQUENTLY ASKED QUESTIONS

Yes and no. Yes, in the sense that you have to prove to the lender you’re a safe borrower, which means you have to submit the standard information about your employment, income, assets and liabilities. No, in the sense that you have to provide extra documentation, such as a building contract, building plans, building specifications and proof of builders’ insurance. Also, some information needs to be provided upfront, while other information needs to be provided before the first drawdown.

There are other finance options. For example, if you’re a homeowner, you may be able to finance your project by taking out a loan or line of credit against the equity in your home. Another option, for renovations, might be to take out a personal loan – the approval process tends to be easier and faster than with a construction loan, although the interest rate is significantly higher.

Yes, some banks are willing to lend to owner-builders, although the lending criteria tends to be tighter than if you were to outsource the work to a construction company. Banks look more favourably on owner-builders who are licenced (rather than unlicenced) – they’re more likely to approve the loan and to accept higher loan-to-valuation ratios. Either way, you’ll have to convince the lender your plans are sound and you can cover any cost overruns.

With a regular home loan, the lender gives you 100% of your money up front. But with a construction loan, the lender makes ‘progress payments’ to the builder – this involves paying out portions of the loan once each stage of the project has been finished. Commonly there might be five or six progress payments – for example:

  1. Laying the Slab/Foundations,
  2. Erecting the frame,
  3. Finishing Roof, Walls & Windows
  4. Installation internal lining (walls, floors etc)
  5. Fit Out (eg kitchen & bathroom)
  6. Practical Completion and handover of the build.

Lenders recognise that building and renovating projects can fall behind schedule, so they’re willing to accept reasonable delays. (The definition of ‘reasonable’ will differ from lender to lender.) In return for the extension, you might have to pay a fee and/or a higher interest rate. If the lender believes a delay is unreasonable, it might cancel the loan (bit this is very rare).

If the project goes over budget, you will need to find a way to cover the extra costs – normally through extra savings. In other words, don’t expect the bank to just increase the amount of your original construction loan. If you watch grand designs, it is the constant changing of the plans that adds to the cost. In Australia we call this variation. Variations before you start are fine, so consider all the options. One the build is underway variations can be expensive.

When a lender approves a construction loan, it does so partly on the basis of the building plan you submit. Changing the plan could delay the project and/or increase its cost, which, in turn, could change how the lender views your project and its willingness to fund your project. If your changes are reasonable, the lender will probably accept them, although you may be asked to fund the changes. If your changes are unreasonable, the lender may cancel your construction loan. Make sure you inform your lender about any changes to the contract, because lenders don’t like nasty surprises.