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Home Renovations - Should I borrow money for this?

Home Renovations

You will probably find that your home becomes increasingly comfortable with the passage of years, just like a pair of favourite slippers. Over time your home ‘takes shape’ around you; it becomes the custodian of many memories; and it offers you a place to retreat to when you need to take some time out.

But, time also brings about a whole lot of other changes. You may have had some additions to the family, or your home may be starting to look a tad too lived in, or the fittings and fixtures may have become just too retro to be funky anymore.

If selling is not an option, then renovating will be.

Once you have made the decision to renovate, you will be faced with deciding on how much to spend and how to pay for it. Should you dip into your cash reserves and savings, or should you borrow money for this?

It is not an easy decision by any account. To answer this question, there are a couple of things you will need to take into account.

Using your cash reserves

Cash reserves could be unit trusts, endowment policies nearing maturity, stocks and shares, bonds, money market savings or any other form of liquid non-debt reserves you may have access to.

One downside of using reserves such as these is that it could leave you without a financial safety net. A second downside is that if you use reserves from an investment that performs better than the total year-on-year costs of financing, you could stand to lose. On the upside, you will not be increasing your debt burden and you will not incur the fees, duties etc normally associated with securing financing. Another upside is that you will be free to harness some of your own DIY skills (sweat equity). If you finance by means of a building loan, the banks could insist that you use a registered builder instead.

If you do decide to use your liquid reserves, don’t use all of it. It is very important to leave some of your safety net intact.

Using borrowed money

Using personal loans, overdraft facilities and credit cards for home renovations, are a bad idea. The interest rates are simply too high. Rather consider securing a building loan, using the money available in your ‘access’-type bond or registering a second mortgage on your home. Carefully calculate whether you will have the capacity to comfortably continue meeting the increased debt repayment burden even if the interest rates had to hike by a further percentage point or two.

The upside of using borrowed money is that it could provide you with access to more money than if you had to use your cash reserves. It enables larger renovations, like additions to your home. On the downside, you could be tempted to spend more than is necessary and you will be decreasing the equity portion of your home.

If you decide to finance your renovation, don’t secure a loan on the entire equity portion of your property. Be specific about what you want to have done and avoid falling into the ever present scope creep trap.

Cash or Borrow?

Building cash reserves is in practice substantially harder – unless you are super disciplined – than repaying borrowed money. Also, your existing cash reserves serve as a buffer against any further economic deterioration and as a safety net should your financial circumstances change.

Even at the current interest rates, there is no cheaper form of credit than a mortgage. Considering the current economic situation, borrowing is preferable to using your cash reserves, provided that you intend staying on in the house for some years, that the renovations will add value to your home and that you can afford the increased repayments.

To conclude

It is worthwhile discussing your decision to renovate with your mortgage originator. They can help you shop around – both at you existing bank and competing banks – for the best possible products, interest rates and terms. They can also help you to calculate the impact of potential rates increases and, because they constantly deal with the financing of projects such as yours, perhaps even point you to some of the reputable contractors they have come across in the past.

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