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How to Finance Your Renovation, Part V
Today we wrap up our five-part series to help guide you through the process of financing your home renovation.
Previous parts are here:
In our final section, we've collected the best pieces of advice that you should consider when researching how to best finance your renovation. Consider this your ultimate cheat sheet for renovation financing.
Tips
When assessing how much financing you'll require, think about your current monthly budget and how much extra you'll be able to slot in. This can vary greatly depending on both the type of financing you opt for and the timeframe needed to pay it back. Needless to say, it's vital that you can afford to finance the renovation. Furthermore, lenders will require that you have a specific loan amount in mind.
When compiling your budget, make sure you factor in rent, storage costs, utility costs for existing home and rental (if not included) and other costs of living while you'll be removed from your home through the course of the renovation.
Don't forget to let your insurance company know you're having your home renovated; depending on the project specifics, it could result in you needing more coverage during the project and more upon completion. This will vary greatly based on the type of project (extensive addition or full gut remodel compared to a main floor reno), so consult with your insurance provider for specific details.
Further to this point, once materials/appliances are installed, they belong to you as the homeowner. So, if a claim were required, it would have to be established which insurance company were to cover it.
Your renovation contractor can help you plan your budget, but if you want to do it on your own, organize everything into a spreadsheet in which you can input all items that you want. This should include specific components, the renovation quote and taxes. This tool will allow you to see which items are making the biggest dents in your budget, so you can adjust or remove on the fly to ensure you're being realistic with your financial plan.
When assessing where you'll get your financing, consider the interest rates. For instance, if the interest on a loan is lower than the interest you're earning on your savings, we recommend maintaining that savings account and not using funds from there to pay for your renovation.
If you are planning on cashing out any investments to pay for a renovation, factor in that any value increased will be taxed as a capital gain, and that may mean a higher-than-anticipated bill come tax time.
Expect the unexpected. When doing your budget, it's prudent to give yourself 10 per cent wiggle room to account for unforeseen events.
When saving for your renovation, this is an ideal time to become more aware of exactly how, where and why you spend and save your money. Reaching your financial goals -- in this instance being able to afford your renovation -- starts with having a complete understanding of your spending habits.
To this point, we believe the best approach is to design the "Full Monty" renovation, but do it in such a way that it can be broken up into phases. For instance, you can do the main floor immediately and the second floor at a later date, but in doing so, you deal with all structural elements and rough-ins during Phase I so that Phase II is essentially pre-prepared, meaning you won't have to break into the first floor a second time, unnecessarily.
If the bottom line is a major factor in your renovation, consider focusing on things that will pay off. For instance, in an effort to rein in your rising utility costs, think about upgrades that will improve your home's energy efficiency, as this is something that will pay off with lower bills and increased comfort.
If you're planning on doing a renovation down the road, now's a good time to ensure your credit rating cuts the mustard so you'll get the best financing terms possible. If you have not had a late or missed payment in a year or longer and don't have any credit cards that are at their limit, chances are you'll be able to secure a bigger loan with the lowest interest rates.
When assessing your financing options, you're sure to hear the term "loan-to-value ratio (LTV)." This is the formula lenders employ to figure out how much financing to give you access to. Basically, it is just over 80 per cent of the appraisal value of your house minus whatever mortgage balance you have remaining. Your credit rating will factor in here, too; if it's good, you may get more than 80 per cent (likely with higher interest rates and fees), and if it's not so great, you may only get 65 to 70 per cent of the LTV.
In conjunction with creating your renovation budget, it's a good idea to also do up a general budget. That will help you figure out exactly how much of a monthly loan payment you can take on for this project.
Why rush things? If you do need to save up money for your reno over time, there are advantages. For starters, you're more likely to do things in bite-sized, more manageable pieces, as opposed to a complete gutting, and all the logistical issues that come with that approach. You may regret some of the decisions you make if you're rushing to complete the project. Going room by room is certainly less daunting, and allows you to keep your budget more manageable over time.
It's important to be aware that second mortgages often have higher interest rates than your first one, so be absolutely sure you can afford the repayment terms.
With that in mind, perhaps the biggest key to determine your renovation financing needs is to have all the possible expenses planned in advance.
As part of your renovation planning process, you should have clearly-defined goals. Are you renovating to increase the value of your home, to increase space or to enhance comfort and become more energy efficient? Or perhaps another reason altogether? This will really dictate what you should focus on.
A good guideline for how much debt you can take on for this project: your total debt (including this project) should be less than 36 per cent of your gross monthly income. Total payment to house-related financing expenses (which includes principal, interest, insurance and any taxes) is advised to be a maximum of 28 per cent of your income. Ultimately, we advise going no higher than a 38 per cent debt-to-income ratio. Note that this debt-to-income ratio is extremely important as it will dictate the monthly payment you'll qualify for.
Obviously, you want to minimize the amount of interest you'll be paying so you can afford to get more financing. Given this, adjustable-rate mortgages could be a method for lowering the interest rate, for at least a while. However, with interest rates currently rising, this may not be the way to go right now. It's definitely something to consider down the road once inflation is reined in somewhat.
With this in mind, you'll have lower monthly payments on a longer-term loan, but wind up paying much more interest. So if you can carry higher monthly payments on a shorter-term loan, you'll save a lot of money in the end.
If you're planning on remaining in the house for the long term, a good rule of thumb for how much to spend on your reno is up to a quarter of the value of the house.
Finally, take advantage of whatever federal and provincial government grants or rebates may be available to you. Many jurisdictions have plans that offer tax credits and financial assistance for projects with a qualified sustainability component. Your contractor should be completely up to speed on what your project qualifies for, so be sure to ask this question.