Renovating an investment property can help attract quality tenants, improve rental returns and potentially add value to your property. But before choosing paint colours or collecting quotes, it’s worth understanding how you’ll fund the project.
Many investors focus on the renovation itself and overlook the impact their funding choice can have on cash flow, borrowing capacity and long-term costs. The good news is that there are several ways to finance a renovation, from accessing equity to topping up an existing home loan. Here’s what you should know before getting started.
Personal loan
Say you want to perform a few cosmetic enhancements. Nothing too major – just a paint job, maybe some new window dressings and/or flooring.
For a small project, a personal loan might be worth considering. Unsecured personal loans don’t use your property as security, and loan amounts and repayment terms are generally set at the time the loan is established.
However, interest rates are often higher than those available on home loans, and loan terms are generally shorter. This could mean that repaying the loan within one to seven years could cause higher monthly bills.
Refinancing
If your property’s value has increased or you’ve paid down your mortgage somewhat, you may be able to refinance and use the equity to fund your renovation. Equity is the difference between the current market value of your property and what you owe on your mortgage.
The perk with this option is that the interest rates are lower than for personal loans. If you’re undertaking a major renovation, it could be worth exploring refinancing, but keep in mind you’ll be adding more debt to your mortgage.
Top-up loan
Another option is to top-up your loan in order to fund your reno. A top-up loan is an extension of your existing mortgage that allows you to borrow extra money (without opening a whole new loan). Lenders usually add the new funds to your loan balance.
Like the refinancing option, this allows you to access lower interest rates than a personal loan or credit card. You will likely not have to pay setup fees that come with getting a new loan, and the approval process is generally different from that of a complete refinance.
It’s important to remember that lenders will usually only let you borrow up to 80% of your property’s value. If you exceed that, you might be up for lenders’ mortgage insurance. Also, because you’re spreading the renovation cost over the life of the loan, you might end up paying more in interest in the long run.
Construction loan
For larger projects like structural changes to your property, you might consider a construction loan. With this type of finance, the lender releases money to you in stages as your builder reaches milestones.
Depending on the loan structure, you may only pay interest on the funds that have been drawn and many lenders offer interest-only payments. This could help you manage cashflow during the renovation. But interest rates can be slightly higher, and there might be extra paperwork (like building plans and contracts, for example).
Line of credit
A line of credit allows you to access equity in your property and draw funds as needed, up to an approved limit. Because you can access money when required rather than all at once, some investors use it to help fund renovation projects.
One feature of a line of credit is the flexibility to draw funds as needed, though it is subject to the lender’s terms and conditions. Interest is generally charged only on the amount you’ve drawn, not the full credit limit. However, because the facility is secured against your property, it’s important to borrow responsibly and ensure you can comfortably manage repayments. If you can’t meet your loan obligations, your property could be at risk.
Use existing funds
If you have savings or you’ve been putting extra money into an offset account or redraw facility, you might decide to use those funds for your renovation.
Just remember it’s always a good idea to keep a little money aside for cost overruns.
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