Financing a Home Renovation
Increasing existing debt levels to fund home renovations can be daunting however the potential for long term rewards can be significant when the project is managed effectively. Following some simple guidelines will ensure the process is as painless as possible leaving one free to enjoy the experience!
Size of renovation/Estimated cost – It’s widely known that as many as 99% of all projects over-run on time and/or money. Even in the most effectively managed projects, overruns can account for between 10 and 20% of the original budget. Although time overruns can usually be managed with effective communication, finance shortfalls can be more problematic. Obtaining additional finance from lenders once the project has commenced, can be very difficult and may leave the un-prepared renovator, in a situation that is feared more than anything (an un-finished project quite often leaving the owner in negative equity). It is therefore critical to ensure sufficient contingency is built into any initial financing.
Timing of Finance – Ensuring the renovation financing is in place prior to the planned commencement date, is essential. Materials will be required before any substantial work can commence therefore In the absence of existing savings available to temporarily fund such purchases, this may often result in wasted costs & time overruns associated with contractors being unable to progress whilst still being paid. Meeting the payment terms of contractors is important to avoid unnecessary disgruntled contractors and more often than not, a diminished build quality.
Remember NEVER commence a project until sufficient financing is in place!
Reducing the Loan To Value (LTV) – By partially funding a renovation project with personal savings, this can quite often reduce the interest rate offered, giving the owner more preferential terms than those looking for a highly geared project.
Types of Finance
Funding a regular purchase vs Renovation – In the current lending environment, obtaining agreement for a mortgage for even a regular property is a challenge. The qualification process is, as expected, more complex than it ever has been before, however it is still achievable if well planned.
Financing of a renovation on the other hand, will be dependent upon how habitable the property is. A property which is currently inhabited requiring renovation is likely to be more attractive to lenders, but most high street lenders will in most cases be hesitant to fund renovation of a derelict or uninhabitable property. This is where specialist finance providers are required.
The LTV offered by a lender will be partly based on how habitable the property is. Habitable properties can see offers of between 80-95%, but will almost always include a retention dependent upon specific works being undertaken. For uninhabitable properties, financing can often be as low as 50% of the CURRENT value, with the option for additional financing as the property renovation develops.
Initial Outlay – Financing anywhere short of the original purchase price plus renovation costs, will require an initial outlay of personal financing. This will cover the shortfall in the purchase price, survey costs and other professional fees. In addition any funds required to kick off renovation work will need to be sourced from available personal funds. Bridging loans can often be an option, provided sufficient equity is available in the property to fund the renovation. Where applicable, this is typically 15-20% of the total cost.
Existing assets – To obtain finance for property purchase and/or renovation, proof of income, liquidity or equity will be required prior to exchange and often as a pre-requisite to the initial offer acceptance stage. Liquidity (short term availability of cash), is viewed favourably by lenders. In addition use of liquid assets such as stocks and bonds can increase loan potential, but potential for significant fluctuation over the period of the loan, may result in these assets being worth less than the remaining loan value at the end of the term. It is important to bear this in mind in any cashflow planning and additional savings should be in place to act as a contingency in such situations.
Existing equity – For landlords with multiple properties, equity can be released to fund renovation or purchase of another property. This can be a very effective way to increase a property portfolio however it is worth considering that releasing equity in a property can increase the risk of properties falling into negative equity in the case of another housing market crash. and when done ineffectively can also impact on credit rating.
Secured Loan/Mortgage – This is often the easiest method of obtaining finance to fund renovation projects but will be inherently limited by the value of the property.
Un-secured Loan – For small renovation projects, or for small short falls in larger projects, unsecured loans can be an effective mechanism for straight forward borrowing requirements, but these are usually limited to approximately £7-15k and are more often than not, repayable over a shorter period of time. Where higher sums are required, they can often be obtained through this route however this will usually be at a higher finance cost.
Whether financing a major property purchase for renovation, or carrying out a smaller project on an existing property, considering finance options as part of the initial planning phase of the project is critical. Obtaining finance more than once due to overruns in time & cost should be avoided wherever possible. Therefore building in a significant contingency, seeking professional advice and hiring where appropriate, a professional project manager, could save a considerable amount in the long run.