Renovations can be expensive, especially to a primary area of your house. Kitchens, basem*nts, bathrooms can all add up to thousands and thousands of dollars. However, there are a few tried and true methods to paying for these big renovations, even when you do not have cash!
When investing in real estate, your equity is transferred, not lost
Before we talk about financing options, it is critical to remember that you are adding value - real value - to your home. Many people that I know think that they have to pay for renovations in cash, and that is simply not the case. Let’s say that you spend $50,000 on a renovation to your kitchen. New cabinets, countertops, backsplash, some light fixtures and even some appliances. Before the renovation, your house was worth $500,000. To make things very simple, let’s say that after the renovation, your house is worth $550,000. A useful way to think of this is that you have simply transferred $50,000 from one place, into the value of your house. In this case, it is a simple equity transfer. Your money has not disappeared, it has just moved from one vehicle to another.
Why is this important? Because this shift in mindset, from one where you are spending money, to one of moving money around, will help you take advantage of a number of financing strategies that you previously might not have entertained. It can help you change from saying I can’t afford it to asking the question how can I afford it?
Take advantage of your ability to move your equity around
“Great. Step 1, have $50,000. Got it.” You might say to yourself. No! This is where things get really interesting. The value of your house can actually provide you an opportunity to get a loan for the whole renovation, that you’ll be able to pay back in full at the very end with nothing out of pocket. Loans can come in the form of a home equity line of credit, an unsecured line of credit, construction loan, or a total equity program product, amongst many others (speak to your broker or lender to see what might be possible for you).
Let’s use the previous example once again, instead this time we will assume that you are using a loan to pay for the upfront renovation costs. We will also assume that you have more than 20% equity in your home to begin.
Starting home value: $500,000
Starting mortgage balance: $380,000
Total starting equity: $120,000
Loan: $50,000
Closing home value: $550,000
Refinance mortgage = $430,000
New mortgage pays off old mortgage and renovation loan: $430,000 - (380,000 + 50,000) = 0
Total closing equity: $550,000 - $430,000 = $120,000
It’s the same! Your total equity has remained in tact, however you now own a more valuable asset (and have the kitchen of your dreams)! The lesson here is that a refinance is just a tool in your pocket to move equity from one place to another. Nothing more.
The hidden costs & risks
With all of this said, there are a few risks and things to keep in mind.
Appraisal: when you refinance, you will need an appraisal to confirm the value of the home after the renovations. There is always the chance that the appraisal comes in lower than expected. The best way to mitigate against this is to speak with your mortgage broker up front, so they can help you select the best financing products in your specific case. Having additional room so that you do not require an 80% loan-to-value mortgage also helps (i.e., if your mortgage has been paid down further, you have extra buffer space in case you need it).
Payments: your mortgage payment after the refinance will be higher. This makes sense, you have a more valuable home, so the payments will go up. But good to make sure in advance you can handle this extra.
Refinance approval: it is best to speak with a mortgage broker in advance to ensure you will be approved for a refinance when the time comes.
Extra fees/costs: a refinance isn’t free, so you will have to factor in a few extra costs. The big ones are going to be legal fees, penalty fees for breaking your existing mortgage, and the carrying costs of the loan. Legal fees can be up to $1000, and penalties can be thousands of dollars which may or may not make the renovation worth it at that particular time. The best way to mitigate this is to time your refinance to line up with the renewal of your mortgage agreement. This way, you will not have to break your mortgage agreement and have freedom to finance with any lender, including your current one.
Rinse & repeat!
Real estate is an incredible investment vehicle for many reasons, however this ability to move around, use, and re-use equity is one of my favourites. These are tools that almost every experienced investor takes advantage of, however is open to any person who owns their own home too. So tell me, have you financed your renovations this way? Have you repeated this method to re-use your capital over and over? I’d love to hear from you in the comments!
