Home renovation has long been a national sport for many Australians, but demand from the home improvement community has reached a fever pitch since the pandemic.
If you’re lucky enough to own a home, and can afford a renovation, chances are you’ve found yourself wishing for a better work-from-home area. Or maybe you’ve thought, “If I can’t travel and have to spend all this time at home, I can also make it more enjoyable to be here.”
Add to that the HomeBuilder grant and you have a market where builders are in high demand, architects are going crazy, and the cost of renovation is rising.
So how do you decide how much you can afford to spend?
There are no easy answers, and a lot depends on housing market conditions where you live, how much financial risk you’re willing to tolerate, and how much you’re willing to give up on luxuries in other parts of life.
But as a former financial advisor and former consumer credit educator for the Australian Securities and Investments Commission (ASIC), these are the questions I encourage you to ask yourself to help you decide how much to spend.
How much more would it cost me each month, even if interest rates went up?
Start by thinking about what you want to do and have a good idea of how much it’s going to cost. Then, be aware of unexpected surprises along the way.
Once you have a rough idea of how much you want to borrow to finance your renovation, plug it into a loan calculator with your current lender or on the MoneySmart website. Add a couple of percentage points to account for the assumption that interest rates might not stay at current record lows.
It’s a good idea to see if you can afford the monthly payments even if mortgage interest rates rise quite a bit in the next few years.
Can I reduce other household expenses?
At this point, while it’s a good idea to do it anytime, look for ways to lower household costs.
Are you getting the best possible interest rate from your lender? If you have a variable rate, you can tell them, “I’m thinking about borrowing more, but I noticed that the rate you have on my loan is higher than what others offer.” Often, they will lower your interest rate somewhat right away. If you have a fixed rate, you can switch to another lender, but remember to factor in any break fees.
Can you cut other costs by getting a better deal on car insurance, health insurance, phone and electric bills? You can often get better prices by simply calling your suppliers and pointing out that your competitors have a better deal.
Think about your next expenses and income
What expenses are coming in the next few years? Are you likely to need a replacement car soon? Are school fees or childcare fees on the horizon? If you did a renewal and could no longer afford vacations, nights out, and entertainment expenses, would you be comfortable with that?
Also think about income. If someone in the household was unable to work due to illness, or wanted or had to work part-time, how would that affect monthly payments?
If something goes wrong or you have an unexpected medical cost, could you afford it even with the added debt that comes with renewing?
As yourself: If there was a drop in my income or a wage freeze, would I be able to sustain the mortgage payments?
What is the return on investment?
This is where the sheer madness of the Australian property market comes into play. Even very conservative financial commentators like myself are forced to admit that the real estate market shows no signs of slowing down or stalling. A renovation is very likely to increase your home’s resale value, but unfortunately there’s no easy way to tell by how much.
A lot depends on where you live. If you’re in a regional area where prices haven’t grown stratospherically, you may need to plan for more moderate growth in your home’s value.
If you’re lucky enough to own property in a major capital city, chances are your home’s value will appreciate even if you don’t renovate it. So if your only concern is increasing resale value, the market can take care of that anyway without the stress of renovating.
There is still a shortage of property in Australia and demand has not even been particularly affected by the pandemic.
But past performance is not always a reliable predictor of future results. So you need to think about how you would cope if there was a big shock to the economy or your household.
crash plan
Ask yourself: how likely am I to lose my job? If I did, could I reliably get another one? How long could you keep the payments if you were unemployed?
Think carefully about employment trends in your industry and what you would do if you were laid off a few years from now.
There are no easy answers in this case. Each person has to make a decision about how well they can tolerate risk.
decide what matters to you
Ultimately, it is up to each person to decide what life they want to have for the next decade or more.
It’s all very well to have an upgraded home, but if you can’t afford to travel anywhere or go out at night again, you should keep that in mind.
If you can afford to see an independent financial advisor, it’s not a bad idea before you launch into a big financial decision. You might also consider seeing a free financial advisor who is independent of any lender. They can be contacted by calling 1800 007 007 or through the National Debt Helpline.
Gregory Mowle is Professor of Finance at the University of Canberra. This piece first appeared on The Conversation.
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