With the increased prices in the Melbourne property market, many of my clients are choosing to renovate their existing property to increase living space, rather than sell and purchase a new home.
The main benefits of this are:
• Avoid new Stamp Duty charges on a new purchase, and put these savings towards renovation costs
• Avoid real estate agent/selling costs on existing property
• Stay in the same house/area
• Add value to your existing property
When looking at the benefits, you also need to weigh up the downsides to renovating. These are:
• The disruption in lifestyle as you have to live through a renovation or in most cases moving out for 6-12 months which generally means an additional rental expense during this period.
• You generally have to move house twice. Moving out and then back into your property once completed.
Financing a renovation involves using the existing equity in your property and applying for a construction loan. The best way to explain a construction loan is that it is like a large line of credit that starts at zero and is drawn-down as construction is completed. This means you only are charged interest on building work as it is completed.
CONSTRUCTION LOAN EXAMPLE
I recently had clients in Melbourne who were renovating their single fronted Victorian home. The property’s value was $1M and they currently had a $400,000 loan on their property. They were undertaking a major renovation that included building upstairs and adding a parents retreat. The total renovation cost was $450,000.
The first step in applying for a construction loan is the bank does an “As if complete” valuation based off the building plans and specifications (fixtures and fittings). In this case the forecasted valuation of the property came back at $1.45M.
Once approved, the construction loan starts at zero. The builder has five stages of the build that are invoiced. These are Deposit, Base stage, Frame stage, Lock up and Final/Completion stage. All these stages add up to the total build cost of $450,000. These stages are listed in the building contract that is signed before construction is undertaken.
All building contracts for construction loans must be fixed cost building contracts, with no variations. Once each building stage is completed, the relevant invoice is sent to the bank/lender. The builder is then paid directly by the bank using construction loan funds.
All construction loans are interest only during construction and can then be reverted back to Principle and Interest after construction is complete. This means at completion of renovation, clients total loan will be $850,000 (existing loan + construction loan), with a property value at $1.45-$1.5M.
In this example if clients sold their existing property and bought a new property for $1.5M, agents selling costs and new purchase costs/stamp duty would amount to approximately $110,000. With the renovation clients moved out and were paying $650 weekly rent for 12 months during construction at a total cost of $33,800. Therefore in this example choosing to renovate their existing property has resulted in a total saving of $76,200.
Finally, and most importantly, before undertaking any major renovation it is vital that you have been pre-approved for a construction loan before signing an unconditional building contract.