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Renovate your home or pay down your mortgage?

The question of whether to renovate or pay down your mortgage is not an easy one to answer. It depends on your situation, the state of the property, and what is important to you.

First up, a couple of assumptions – you’re not looking to sell any time soon and are calculating returns from an investment point of view. You want to spend a lot of money knocking out every wall and putting in mirrored ceilings? That’s a totally valid choice, whether it gives you a return on your investment or not (and we can safely say it won’t). Renovations are often for entirely emotional reasons, at which point advice from mortgage websites are pretty pointless. So if that’s you, close your browser and get started knocking down those walls. If however, you’re wanting to make a financially sound decision, read on.

The three elements to consider:

Should I renovate my home to add value?

Investing in renovation means you are betting that the money you spend will result in your house being worth more; ideally more than what you spent, resulting in capital growth.

It can be tricky to know whether a renovation will make or lose you money. Even when you sell your house you will likely not know how much additional money the renovations brought in. Prospective buyers are considering so many things and often use their gut feeling to decide the worth of a property. They will not necessarily put an actual number on how much they value the tastefully updated kitchen – but it will almost certainly positively influence their offer.

Prospective buyers do however often put an exact number on renovations that they see as required and can use these numbers to reduce their offer. This doesn’t necessarily mean renovations would be worth doing before selling but it is a good thought exercise to do. Looking through the lens of a one-day-buyer, what would give you pause? What were your thoughts when you bought it? Did anything make you reduce the price and if so by how much? This can help you identify where your money would be best spent and get a feel as to whether the investment would pay off.

Keep in mind also that some buyers don’t want to go to the hassle of fixing things up themselves. If your property obviously needs work you may get fewer offers. This is especially true if your property wouldn’t be categorised as a first home or investment property.

The following are said to have a good return on investment, but it is, of course, entirely dependent on the condition of your property and area you live in.

  • Entry door replacement (steel)
  • Deck addition (wood)
  • Minor kitchen remodel
  • Cladding replacement
  • Bathroom remodel
  • Roof insulation

Whereas common wisdom says the below things are not usually a good investment:

  • Dramatic decors – eg loudly patterned feature walls or patterned tiles in the bathroom. A style currently popular can age quickly.
  • Changing up flooring – carpeting over hardwood floors and vice versa
  • Extensive landscaping
  • Top of the line kitchen appliances

This article is about renovations without any current plans to sell. But it is worth noting a general freshening up of your property at the point of sale is always smart. Fix any damaged walls and tired paint jobs. Replace carpet only if there are visible permanent stains, holes, or heavy wear. Give the garden a good tidy up. Doing these things without planning on selling is great but be aware that at least some items will likely need to be redone when you go to sell.

Lifestyle is an important thing to consider when looking at whether renovations now would bring you any additional money when you sell further down the track. Children and pets especially add wear and tear, reducing or eliminating any value added by the time you go to sell.

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Have you borrowed over 80%? Then it may be time to renovate

Mortgages over 80% LVR have higher interest rates, with most banks charging between 0.25% and 0.75% more.

A renovation may result in a higher valuation that gets you below that 80% threshold, saving you a lot on your mortgage. Valuers compare to recent sales in the area, but also take into account things such as modernised kitchens, new carpet etc.

Example:

You have a $500,000 house, with a $415,000 mortgage (83% LVR). You have $10,000 in cash which you spend on renovations. Your revaluation increases your property value to $520,000. Your mortgage is still $415,000 but that is now 79.8% LVR.

If you had put that $10,000 into paying off your mortgage that would have only got you to 81% LVR (a $405,000 mortgage for a $500,000 house).

The interest rate savings of a mortgage below 80% are at least 0.25% = ~$1,000 per annum. You will have both saved money in interest and increased the value of your house, a great result.

Note: Banks will not reassess the value of a house within the first 6 months after purchase so you’ve got some time after your purchase.  Some banks will then allow the additional interest to be removed immediately.  Others require the loan term to mature before removing it.  If you are looking to renovate to increase capital growth, mention this to your adviser early so they can pick the right bank for your strategy.  If you must go to the banks that require the loan term to mature, make sure you fix for a shorter term (1 year) so you’re not paying the premium for too many years. (here's an article on 3 questions to ask when you refix your mortgage)

Should I pay down my mortgage to reduce debt?

Paying down your mortgage sooner means guaranteed less debt and therefore less interest paid over the life of the mortgage. However, putting all your money into your mortgage and none into improving your property could lose you money when you sell your house. (here's an article on how to get in the mindset of paying down your mortgage)

Example:

You have a $500,000 house with a $400,000 mortgage. You have $10,000 in cash. You could use it to update your kitchen and get the valuation up to $520,000, which in turn will hopefully pay off when selling. Or you could pay down your mortgage to $390,000 (saving $250 per year in interest). Capital growth isn’t certain like reducing debt is but could earn you more in the long run.

Enjoying your house

This third aspect is very personal, it’s about identifying the value you place on enjoying the fruits of the renovation while you live there.

As said at the outset, it's valid to do renovations for your own benefit (eg; maybe you’ve always wanted a scullery) but be aware making decisions from the position of what you personally would prefer can reduce the likelihood of it paying off at the point of sale. Having said that, unless your tastes and needs are eccentric you will likely get at least a bit of your money back at the point of sale.

Often paying down your mortgage then renovating just before selling makes the best financial sense. You’ve benefited from reducing your debt as much as possible as soon as possible. Then any renovations at the time of selling will get the highest return on investment as any changes will be fresh and at their best. However, if you want to enjoy the improvements yourself that may outway the financial benefits of this approach.

Ultimately only you have the answer

What do you value most? Feeling more financially secure as soon as possible or living in your dream house that you have tailored to your specific taste? Or, more likely, some scenario in between?

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