Using equity to renovate: top-ups, refinancing and construction loans

There are five main ways to pay for a renovation, and you can combine them:

• Savings, including money already in your loan. Extra repayments you can take back out (redraw) or savings sitting in an offset account (a savings account linked to your loan that reduces the interest you pay) need no new application. Our FAQ on offset and redraw explains the difference.
• A top-up with your current lender. Your lender increases the loan and pays the extra to you. Lenders also call it a loan increase or an additional advance.
• Refinancing to a new lender and borrowing the extra. The new loan pays off the old one plus the cost of the work. Lenders call the extra part cash-out.
• A construction loan for structural work, paid out in stages as the builder finishes each part.
• A personal loan. The interest rate is usually much higher than a home loan's, and the short term means bigger repayments, which can cut what you can borrow later. We usually suggest one only for short-term finance, or when the amount is smaller than a lender will add to a home loan.

If you'd like the renovation paid off sooner than the rest of the loan, many lenders let you put the extra in its own split (a separate part of the loan with its own repayments). A broker can check whether a lender will set a shorter term on that split, or work out the repayments that would clear it faster. Adding the renovation to your home loan increases the debt secured on your home, so your repayments can rise, and spreading it over the rest of a long loan can mean paying more interest in total than clearing it sooner.

The rest of this guide is about the middle three: borrowing against your home.

Your equity is what your home is worth minus what you still owe on it. Lenders won't usually let you borrow all of it. Once the loan goes above 80% of the home's value, lenders usually add lenders mortgage insurance (LMI, insurance that protects the lender when your share is small, and which you pay for), and some set a tighter limit on how much extra you can take out. Lenders measure this as your LVR, your loan as a share of the home's value: owing $500,000 on a home worth $950,000 is an LVR of about 53%, so there is room before you reach 80%.

Equity is only half the test. Borrowing more is still a lending decision: the lender has to check that you can afford the whole loan, not just the extra, on your income and expenses today. Some reassess you in full, while some offer a quicker increase for smaller amounts to customers with a good repayment history. Lenders test the repayments at a higher interest rate than the one you would pay, called the assessment rate or buffer. So someone with plenty of equity but a lower income than when they bought, or new debts since, may be able to borrow less than their equity suggests.

Most lenders accept a renovation as a reason to borrow more against your home. What they want to see depends on how much you're borrowing:

• For smaller amounts, many lenders need only a description of the work and roughly what it will cost.
• For larger amounts, expect to provide builders' quotes, a contract or a signed statement of what the money is for. Some lenders pay larger amounts out against invoices as the work is done, rather than all at once.
• With LMI, some lenders ask for more evidence, at lower amounts.

Two more differences between lenders matter. Some don't offer top-ups at all, so the extra comes as a new loan or a refinance. And a top-up isn't always simpler than refinancing: the lender still checks you can afford the bigger loan, and some reassess you in full, so it can be worth comparing your current lender with others before you choose. And if part of your loan is on a fixed rate, a top-up at some lenders means breaking it, which can cost you, so check before you apply.

A kitchen, a bathroom, new floors or a repaint can usually be funded by borrowing more against your home. Bigger work is different. Lenders usually treat these as construction, not a simple top-up:

• Moving or removing walls, adding rooms or a second storey, or changing the roofline (structural work).
• At some lenders, work that needs council approval, or any renovation above a certain cost, structural or not.

A construction loan is paid out in stages (progress payments) as the builder finishes each part of the job, and lenders usually want a licensed builder working to a fixed-price contract. Some lenders won't lend to owner-builders at all, and those that do usually lend much less.

Today's value or the finished value

This is the difference most guides skip. When you top up or refinance, the lender values your home as it is today, so the value the renovation will add doesn't help you borrow. With a construction loan, the lender can value the home “as if complete”: what it will be worth once the work is done. That can let you borrow more for a large renovation, but it comes with the construction loan's conditions: plans, a building contract, and payments in stages.

In our home loan comparison tool, choosing “Construction” as the property type greys out the lenders that don't offer construction loans. A lender whose answer depends on the details stays in the list, for a broker to confirm.

If you're buying a home to renovate, the renovation money can often go into the same application as the purchase, as long as you can give the lender full builders' quotes and specifications in time. Work that needs council-approved plans usually can't be ready before the purchase has to settle, so it is often funded afterwards: by a top-up, or a construction loan if the work is structural. Most lenders will consider a renovation top-up soon after settlement. Some want a few months of repayments before other kinds of cash-out, but for a renovation a broker can often apply as soon as the loan has settled.

This is an illustration, not a quote.

Ben and Leah: a couple in Melbourne's east with two primary-school children. Ben works full time and Leah part time, both in permanent jobs they've held for years. They want to redo the kitchen and bathroom without moving any walls, and are refinancing to add the cost to their home loan.

Ben's salary

$105,000 a year

Leah's salary (part time)

$55,000 a year

People on the loan

2, with 2 children

Living expenses

$4,500 a month

Home value today

$950,000 (Melbourne)

Current loan

About $500,000, being refinanced

Renovation

About $120,000, kitchen and bathroom

New loan

$620,000, owner-occupied, 30 years (an LVR of about 65%)

What moved the figure

• A recent statement for your current home loan.
• Builders' quotes or a contract for the work, or your own list of the main costs if it's early days.
• For structural work: plans, council approval if it's needed, and your builder's licence and fixed-price contract.
• Your two most recent payslips and your latest income statement or tax return (both of you, if two of you are on the loan).
• Statements for any other debts, including credit cards and car loans.