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Last Updated on 20 June 2019

How to Finance a Home Addition



Home additions can add significant value to your property, but they don’t come cheap. Finance is an important factor in planning your addition, and you have a few options. Should you go with a construction loan for a home addition or a renovation loan?

In this guide, we’ll go through your options to help you determine how to finance your home addition.

Key Points
  • Home additions include adding an extra bedroom, granny flat, carport, garage, or even an additional level. These additions can add value to your home and increase your home equity.
  • Construction loans for a home addition allow you to save on interest, as funds are drawn down in stages and you only pay interest on the funds you have received.
  • Renovation loans let you access your home equity to finance a home addition, either through redraw facilities, loan top ups, or other types of credit products.

 

What is a Home Addition?

Renovations can take many forms, from a new coat of paint to a total knock down rebuild. Home additions fall somewhere between these two: you’re not building an entirely new property, but you’re doing much more than cosmetic improvements.

A home addition, also referred to as an extension, is generally defined as adding a new structural feature to an existing home. For example, a garage, granny flat, or extra bedroom. Regular home improvements or repairs are not considered additions.

Home additions take time, planning, and finance. You’ll need to work with a builder and possibly an architect to get your plans ready to go. These plans will then need the requisite council approval before work begins.

Of course, before anything can happen, you’ll need to organise your finances.

Getting a Quote for your Home Addition

Before you can finance your home addition, you’ll need an idea of how much it is going to cost. The price of materials, labour, and permits can add up quickly, not to mention unforeseen circumstances. The more extensive your addition, the more it is likely to cost.

If you plan to seek external financing, you’ll need a quote from the builder that you can take to your lender. There are two different types of quotes you might receive.

Fixed price quote

A fixed price tender for an addition is the builder’s assessment of how much the project will cost, allowing for unexpected events like weather delays or fluctuating material costs. There is usually a bit of fat built into the quote to protect you from spiralling costs.
This type of quote is based on a defined amount, or a lump sum. However, there is still a possibility that the final price will be different than that of the quoted price.

Cost plus quote

A cost plus quote carries an element of uncertainty. The builder quotes a fixed price for the cost of the building work, with further invoices to follow for the cost of materials and labour.
With a cost plus contract, there is no final fixed price for the project. Homeowners may end up with a large bill if the project does not run to schedule.

In either case, have a detailed building contract in place before any work commences. It should detail the scope of works, timeline, cost, terms of payment, and contingency plans. You can also implement a budget cap for the project stages, so you know the maximum amount you will be billed.

Once you have your quote, you’re ready to seek financing.

Construction Loan For Home Addition

A construction loan has a unique payment structure, making it ideal for a new construction or home addition. While a traditional home loan pays out a lump sum on settlement, a construction loan uses progress payments, releasing the funds out in stages.

At each stage of the addition’s construction, the lender conducts a valuation to ensure that the stage has been completed to standard. Once the value is confirmed, the funds for that stage are released. The loan is not paid out in full until construction is entirely complete.

The advantage of a construction loan is that you only pay interest on the amount that has been drawn down. In some cases, you can pay interest-only until the loan is fully drawn down. This saves you money and helps you manage your cash flow during construction.

A construction loan also allows you to take advantage of the lower interest rate associated with home loans, as compared with rates for personal loans or credit cards. However, you will have to apply for a new loan on top of any existing loans.

Renovation Loan for Home Addition

Renovation loans come in several forms. Some allow you to access your home equity, while others require you to take out a new loan or credit product.

Access Home Equity

Home equity is the proportion of your home that you own. If your home is valued at $600,000 and you owe $200,000 on your loan, then your home equity is $400,000. There are three common ways to access your home equity to finance a home addition.

  • Redraw Facility: Make extra repayments on your home loan, then redraw them as needed.
  • Home Loan Top Up: Borrow more money on your existing home loan based on your home equity.
  • Line of Credit Loan: New loan with a revolving line of credit, secured against your home equity.

Refinance

Some homeowners may choose to refinance their existing loan in order to access more money for a renovation. They may switch to a larger loan with a lower interest rate, making it more cost-effective. The extra funds can then be used for the home addition.

Personal Loan

A personal loan is usually a better option for smaller renovations. It provides a lump sum quickly, but often has a higher interest rate than home loans. This may not be the smartest option for financing a home addition, which tends to be more expensive than minor renovations.

Other Financing Options

If you have substantial savings, you may be able to pay for your home addition in cash. This keeps you from taking on more debt, and you won’t have to dip into your home equity.

Credit cards can also finance home additions, though they have higher interest rates than home loans. Look for a card with a low interest rate (15% or less) and a credit limit that is within your renovation budget.

Keep in mind that using a credit card can be risky, as you will still need the funds to pay it off.

Comparing Home Loans for Additions

It’s hard to know which type of loan is a match for you until you shop around. Loans can vary widely between lenders, so it pays to compare. Here are some things to look for when comparing different loan types.

  • Terms and conditions of the loan
  • Interest rate
  • Fees and charges associated with the loan
  • Features of the loan
  • Application criteria for the loan

Save yourself time and money by comparing loans online with ratecomparison.com.au, where you can get a quick snapshot of your options, all in one place.


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