Financing Your Renovation

house with coins 145x178When it comes to property renovation, money is definitely everything!

I’m talking about a fact of life. And that fact is that there‘s no point in going out into the market to search for properties to renovate unless you have some idea about what you can afford to purchase and what you can afford to borrow!

Here’s what I mean: You’ll need to have funds available to…

  • Buy the property.
  • Pay for stamp duty and legal costs
  • Fund the renovation, and,
  • Cover the costs of holding the property until it’s re-sold.

Before getting into the different sources of funding it’s important to understand some basic but fundamental concepts: here goes:

Debt, leverage, and loan-to-value ratio – it’s essential that you understand them right from the start so you know that you have the proper financing in place for any renovation project.

Good Debt vs. Bad Debt

In basic terms, ‘bad’ debt is money borrowed to buy things that lose their value over time and that don’t help you to earn any income. This might include cars, boats, or any luxury item.

‘Good’ debt, on the other hand, is money borrowed to buy things that go up in value over time and help you make more money…like houses!

My point is that, it’s okay to borrow money if you are going to use that money to make more money.

The Power of Leverage

When we’re talking about property, leverage (or gearing), is the use of debt to purchase a house.

Leverage is an important part of property investing, and here’s why: Banks and other lenders see property as a secure investment. So, that means they’ll allow you to leverage a small amount of savings to buy a property and have that bank fund most of the purchase price!

Now, when you borrow for a renovation project, you only need funding for a relatively short amount of time, so it’s not as critical to get the “perfect deal.”

However, if you intend to hold the property and rent it out, then you’ll want to get the best deal possible. That way, you can keep the costs of the loan down over time.

The objective of obtaining finance for a renovation project is to really just to secure the deal.

Sure, you don’t want to pay ridiculous rates of interest or exorbitant establishment and exit fees. These costs will reduce your end-profit. But you do want to get the funding or you won’t have a project to do!

Loan-To-Value Ratio (LVR)

This ratio is used by the finance industry in order to determine risk in terms of any property loan.

Generally speaking, lenders have lending policy limitations in place based on LVR. This gives them a buffer to protect the debt in case legal recovery of that debt is required.

Here’s how LVR is calculated: You divide the value of the property by the loan amount. Here are a couple of examples to show you how the calculation is done:

  • Example 1: If you purchase a property valued at $300,000 and you borrow $240,000, then the LVR is 240,000/300,000 or 80%.
  • Example 2: If you’re paying off your home which is valued at $400,000 and you owe $200,000, then the LVR is $200,000/$400,000 or 50%.

In general, the value of the property is determined by the lender’s valuation process which is usually the lesser of the purchase price or valuation conducted by the lender’s appraiser.

Provided you meet their lending criteria, most banks will fund up to 80% of the value of the purchase price of the property using the property itself as security.

So, how does this relate to you? Well, you may be able to get a higher or lower LVR, depending on:

  • Your ability to service the loan
  • The location and type of property you want to buy
  • Your current level of borrowing, etc.
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