How to put your reno on a solid foundation

Borrowing may make sense, but stick to your budget.

Deanne Gage 19 February, 2013 | 7:00PM

Undergoing a home renovation isn't that much different from general financial planning. Successful ones will reflect your goals and what you can reasonably afford. But without a concrete plan that's followed diligently, it's easy for things to fall off the rails.

The first step is figuring out what the reno will cost -- everything from the renovation drawings to the contractors you ultimately hire, says Mary Ann Kokan-Nyhof, a certified financial planner (CFP) with Desjardins Financial Security Investments in Winnipeg. She recommends talking to many contractors for estimates. Don't base your plans on the cheapest estimate you receive but ones in the mid-range, she adds.

Ideally, you'd save up for your renovation and pay for it directly. But larger projects -- like adding an addition -- can cost $100,000 and up, so that may not be feasible for years. You could cash some of your investments earmarked for retirement but there could be steep tax consequences and you could be hindering future compounding growth.

So, what are your options for borrowing the money for your renovation project?

Construction financing

This type of loan is available at your financial institution. You don't receive the full amount of the loan at once but are advanced percentages of the money based on certain stages of the renovation's completion. Once you've finished the renovation, the loan is converted to a permanent loan at a fixed interest rate and you usually start paying back the loan one month later.

 
Mary Ann Kokan-Nyhof

As with applying for a mortgage, you need to show proof of your income and be in good credit standing. But for a builder's loan, you also need to show your complete renovation plans for the house, including hiring an architect to design the plans, getting a professional engineer's stamp of approval on those plans and, of course, showing the various building permits required for the project. The financial institution will hire an appraiser to evaluate your entire project and what is deemed the final value of the renovated home, notes Kokan-Nyhof. "That value is what the financial institution is willing to give as a loan," she says.

Home equity line of credit

A HELOC allows homeowners to tap into funds worth up to 80% of the property's value. "The benefit of a HELOC is you can use it whenever you want for what you want," Kokan-Nyhof says. Let's say you have a home valued at $500,000 with no mortgage. Since you have 100% equity in the home, you'd qualify for a $400,000 HELOC. But let's say there's a $200,000 mortgage on the $500,000 home. That translates into $300,000 of equity so $240,000 is the maximum HELOC amount you can borrow.

To get a HELOC or apply for a larger HELOC than you currently have, your financial institution will hire an appraiser to assess your home's value. They will also confirm your income levels and your credit standing. You'll need a lawyer to review and sign off on your HELOC application.

Mortgage refinancing

Let's say you currently have a $100,000 mortgage and need $200,000 for your renovation project, for a revised mortgage of $300,000. Whether you would be approved depends on the equity in your house, the house's value, your credit standing and your assets and liabilities. Last year, new mortgage rules limited the maximum gross debt service to 39%, but many experts believe you should borrow at considerably less than what the financial institution says you qualify for.

Kokan-Nyhof faced these options when she and her husband purchased a small fixer-upper home with the intention of expanding the property. In the end, they decided to go with construction financing.

Sticking to your budget is key with renovation planning, says Catherine Hurlburt, a Vancouver-based senior financial planner with Assante Financial Management Ltd. and Integrated Planning Group. When Hurlburt and her husband extended their house a decade ago, they wouldn't deviate from their budget. In fact, she would sit down with their contractor each week to track spending. If things were tracking higher than expected, she would find ways to reduce spending in other areas -- or postpone some of the planned expenses (such as landscaping, built-in bookshelves) until they saved enough money and could pay with cash.

Kokan-Nyhof agrees that many homeowners are surprised at how easy it is to lose sight of the budget. "It doesn't take long for things to add up," she says. "Your budget for door hardware is $95 each but the pretty one is $150. It's only $55 more but do that enough times in your budget and things can really spiral out of control."

That said, anyone who has experienced a renovation first-hand will tell you the project always costs more than expected. Problems like electrical not being up to code or structural problems may present themselves as construction begins.

"We have in-floor heat in our bathroom because we couldn't get ductwork through the bathroom walls," Kokan-Nyhof says. "While it's a nice luxury to have floor heat, it costs more and it wasn't in the original plan." That's why she recommends having at least 25% of extra funds for contingencies.

About Author

Deanne Gage

Deanne Gage  Deanne Gage is a Toronto-based writer who has specialized in personal-finance issues since 1999. A recipient of several journalism awards, including one from the Investment Funds Institute of Canada, she is also a former editor of Advisor's Edge and Advisor.ca. She can be reached at deannegage@gmail.com.