If you are about to renovate, please consider

There are few things more satisfying in the property world then completing a successful renovation. I guess that’s why shows like The Block, House Rules and Reno Rumble have all been so popular over the years. And yes, there’s a hint of jealous from me, the white collar professional who has zero skills on the tools for tradies who are capable of completing such a feat

So if you’ve ever thought about doing a bit of work to your house or maybe even a complete knockdown and start again, this post will show you how the finance side of things works and two of the most common traps you need to be aware of.

Trap #1 – The low valuation result

Whether you’re building a home from scratch or putting in a new bathroom and kitchen, a lender will make you do is provide them with a fixed price building contract that outlays what work and the cost that is to be done.

What they will then do is order what they call an “as if complete” valuation on your property. What is meant to happen with these types of valuations is the valuer is meant to review the works to be completed and then provide a figure of what the property will be worth upon completion.

The reason why I say “meant to” is because typically, as if complete valuations do not pan out exactly as they should…

There’s an old saying in property that every $1 spent on a renovation will equal $2 in improved value. However, the reality is all that happens with these valuations is the valuer will simply add the cost of the renovation onto the current value of the property.

For example, let’s say that your property is a two bedroom, one story house worth $700,000 and you plan on spending $300,000 to add an upstairs, turning it into a two story, four bedroom house. You would think that this type of transformation would probably result in the property being worth $1.2M. However, unfortunately what will end up happening is the valuer will simply just add the current value with the price of the building contract to come up with a figure of $1M.

This is important to note because let’s say that gainst your property worth $700,000 you have a debt of $595,000, which is an LVR of 85%. If the valuer did in fact value the property at $1.2M it would mean that although your loan would increase to $805,750, the overall LVR would be 67% meaning that you would stay under the 80% mark where you need to pay LMI.

However, like I said, it’s very unlikely this would happen, so the reality is that the loan would be $805,750 against only $1m, resulting in an LVR of 89% and an LMI fee of $6,500!

So, when planning your renovation, don’t get ambitious about what you think the property will be worth once everything is completed. You’re better off simply working your figures off what your property is currently worth and then adding the cost of the renovation to that price.

Trap #2 – The higher interest rate

One of the biggest marketing ploys that banks have is providing customers with “discounts” off their standard variable rate. If you’ve ever dealt with a bank before, you may have heard them say, “Because you’re one of our premium customers, we’re happy to provide you with a 1.2% discount off our standard variable rate for the life of the loan!” Of course, the reality is EVERYONE gets “the discount” so it’s really important you understand what the ACTUAL rate is going to be before proceeding.

Now, when I said everyone, that wasn’t entirely the case…

For some lenders what they’ll do is tell you that during the construction period they “have to” move you to the standard variable rate until it’s completed and then they will apply the “discount”. Depending on the length of construction, this differential can really add up. For instance, using the same example, if with the 1.2% discount, your usual rate was 4.5% it would mean that during construction, your rate would increase to 5.7%.

Most major renovations take around 6 months to complete so this differential would end up costing you nearly $5,000 in extra interest.

As such, when talking with your existing lender, ask them if your interest rate will increase during the construction period. If it will then you might want to consider switching to a lender who doesn’t load your interest rate.

So there you go, two important traps you need to be aware of before commencing with your next renovation. That’s something I don’t recall Scotty Cam ever mentioning before!

Tim Russell is the Director of MultiPart Finance