Common Cents: Renovation Financing
Most of us enjoy making small improvements to our own home, but what about the big stuff? And what about financing a larger renovation? Will it improve your home’s resale value? What will give you the most bang for your buck? How should you obtain credit to finance a large renovation? I spoke with four professionals and asked them all about the financial side of renovating a home.
Development Manager Eurodale Developments Inc.
General Contractor Owner - Green By Design
Director of Mortgage Advice TD Canada Trust
AACI President Elect Appraisal Institute of Canada
In this economy, what do you hear from people as their main worry about renovating their home?
BC: Typically they are fearful of overspending and not getting the return on their investment. There is more value in a well-designed renovation.
Is this a good or bad time to renovate your home, and why?
BC: It’s a great time to renovate. Interest rates are at historical lows and material rates are still (somewhat) depressed given the stoppage of work in the US. This will be a different story when interest rates rise and the US housing crisis sees a solid recovery. Lumber prices have already increased 18 percent since January 2012 with only a very minor re-start to new home construction. Once things are back to normal growth rates and interest rates begin to climb, the costs will be much higher than we are seeing today.
FH: In the current real estate environment, many home owners may decide to give their home a facelift instead of moving, seeing renovation as a less expensive option since housing prices are so high. Renovating lets you keep what you like about your current home and change what you don’t like, and is usually a more affordable option than moving. Some renovations can save you money on your energy bill, allow you to generate income or even save you money on insurance premiums.
Assuming people have the skills to complete a part or all of the reno, will renovating your own home save you much money, in the long run?
BC: Of course, assuming they don’t mess anything up of course. Sweat equity will save you immensely in the labour costs, but you must ask yourself if it is the best use of your time and energy, or if it makes better sense for you to be doing something else and leaving the project up to the pros.
MD: When deciding what you will hire out and what you will do yourself, you’ll need to weigh your skill set, priorities, and quality tolerances for both the process and the end product. You may have always wanted to tile your bathroom, but you may not know how. If you learn how, it may not turn out as professionally as if you had hired the work out, but you will have had the satisfaction of doing it yourself, which may be important to you. If you want to act as your own general contractor because you want to, that may be doable, but if you do it only to save money it may end up costing you more. Bringing together a group of tradespeople who need to dovetail together their services on a project like a bathroom is no small feat. If you have to give up pay to complete the work, in the long run it could cost you as much, or more, as hiring someone else.
Are there general situations when you advise people not to spend money to renovate?
BC: If the house is not structurally sound, it may make better sense to tear it down and build new. Likewise, if it will create crushing debt issues then obviously it doesn’t make sense.
FH: According to Canadian Mortgage and Housing Corporation guidelines, your monthly debt load (the amount that goes towards paying down debt each month) should not be any more than 44 percent of your total pre-tax monthly income. Although renovating your home can be a wise investment, if financing the renovation will bring you over that threshold, you should concentrate on paying down debt before renovating.
DW: Renovations in homes that are already priced at the upper end of the range for the neighbourhood (i.e., your house is the highest price home on the block) will generally provide lower returns than those priced at the lower or mid-range for the neighbourhood. Replacing items for personal taste – modern style cabinets with another type of cabinet – will not provide returns to the degree of updating dated cabinets with modern cabinets. Also renovations in homes that have maintenance problems will have a much lower impact on re-sale price. For example, renovating the bathroom when the roof needs replacing is a bad idea.
Are there certain types of renovations that you would recommend over others?
BC: Not often thought of as renovations, general maintenance and upkeep is key to protecting your investment. I would put that at the top of the list. Second, I would suggest your money is best invested in a kitchen and bath renovation since they yield such high return on both enjoyment value and resale value. If you are seeking additional space, don’t discount the basement remodel or the attic conversion. They can be a cost-effective way to obtain great additional living space.
FH: Many times there are green options for your renovation project that I’d recommend investigating. For example, if you’re replacing your windows, look for insulated glass. Sometimes these options cost a bit more initially, but they can make sense financially in the long-run.
DW: Generally, landscaping and painting are cost effective high return renovations. Followed by flooring, kitchen and bathroom renovations. However, always keep in mind the price level of your home and its position in the market. Putting a million dollar kitchen in a $50,000 house simply does not make sense. In some areas of the country, outdoor living areas (well-constructed decks and patios) are also a good investment.
What are the best ways to obtain credit/cash in order to complete a renovation?
BC: I suggest working with a mortgage broker to find the institution that is providing the most competitive rates, and are familiar with the home renovation lending process. HELOC’s (home equity line of credit) has proven to be the easiest, second would be a refinance of a current mortgage. If your lender has a series of stage draws, ensure your project funding works with their proposed draw schedule.
FH: A home equity line of credit or a mortgage refinance both allow you to use the equity you’ve built in your home to finance a renovation. It can be a lower interest option than other forms of credit (credit cards, unsecured lines of credit, etc.). With either option you can access up to 80 percent of the appraised value or purchase price of your home (whichever is lower) to apply toward the renovation. Crunch the numbers with a financial advisor, who can help you decide if this is the right investment for you. With a home equity line of credit (HELOC) you can access up to 65 percent of the appraised value of your home. A HELOC offers similar access features to a personal line of credit however since your home equity is attached to it as collateral, it carries a lower interest rate than a standard unsecured line of credit. You do not withdraw the money until you need it and you only pay interest on the amount used. You can withdraw all or part of it at any time, and pay some or all of it back as you wish. You can access even more of the appraised value of your home (sometimes up to 80 percent) through a mortgage refinance. When you refinance, you borrow the full amount and therefore will pay interest on the full amount as you pay back the money (vs. a line of credit where you only pay money on the amount used). There are a variety of terms, interest rates and repayment schedules available, and the benefit is that you will only have one mortgage payment to contend with monthly.
At what point does increasing the scale of your renovation make sense?
MD: My wife and I recently decided to undertake a major renovation on our home. We chose to break it into two stages to make it more manageable. We rented a house and moved out for three months and approached the work required within the existing footprint. Phase one was a big deal, both in scope and cost. When you’re already up to your knees in the process, sometimes it makes sense to wade in a little bit further while you’re there, as much as you really don’t want to. That’s what we did. Because we weren’t living there, and so much was open, we tore out a chimney and fireplace, added a window, moved half the walls in our house, and we ended up rebuilding the second story floor from beneath. You have to come to grips with the dangerous truth that when you start ripping and tearing, you will be temporarily decimating the value of your investment, and then proceed gleefully in order to make it better.
What are some of the tax credits or other savings often associated with renovating a home?
BC: Though these are always changing, currently there is a substantial renovation GST rebate, and if you move out for the renovation MPAC will adjust the taxes that are payable during the renovation timeframe. Google and the CRA websites are your best resources.
Is there a financial and time “buffer” you would recommend to folks considering a large renovation?
FH: I recommend homeowners build in a 10–15 percent contingency plan for budget overruns. You should also give some extra time for completion. A week-to-10-days grace period to have a project completed should be reasonable for a smaller project, but could be much longer for a big project. Your key will be to revisit your initial plan and your budget throughout the renovation as this will help keep you on track.
MD: Get quotes or estimates on the work you will hire out. Detail out all the costs of the materials as well as anticipated waste (usually 5 percent) and don’t forget to factor in tax to the totals. Decide whether you will count your own time and sweat equity you will invest in the project, especially if it pulls you away from being able to make other income. And then when you have a comprehensive total, add 20 percent for a grand total. That 20 percent will encompass the inevitable unpredictability of a renovation project. Whether you encounter mold, asbestos, pest damage, structural or mechanical issues that 20 percent, when you’ve reconciled yourself to it, will be your peace of mind.
How much money should people expect to receive on their renovation investment when they sell their home?
FH: Before deciding to renovate, you should think about what your priorities are for the project. The renovations that will really increase resale value can be things that you won’t even notice day-to-day because they are below the surface and not aesthetic changes – things like updating your electrical systems, ducts, plumbing, heating, etc. On the other hand, some renovations or upgrades can make a big difference to your level of comfort in your home but may not make a big difference when it comes to increasing the resale value. If your goal is to increase resale value, before deciding on a renovation budget it may be a good idea to consult with a local realtor who can show you comparable homes in your neighbourhood, what condition they were in and what they sold for. The Appraisal Institute of Canada provides an online tool that can help you evaluate the potential return on your renovation investment.
DW: Returns on money invested will vary from project to project and market to market. A large number of factors will contribute to the return homeowners can expect. A designated appraiser (AACI or CRA) with experience in a specific market can provide the best localized insight on the returns in a given area.
What things are home buyers drawn to when looking through a home they are considering purchasing?
DW: Firstly on the exterior that the landscaping is well kept and the exterior of the home is either freshly painted or nicely kept – it is a cliché but curb appeal goes a very long way. With the availability of listing information on the Internet, buyers have the ability to look at hundreds of homes before even leaving their couch. If the exterior of the home does not present well, you may not get a first look. On the interior, neutral colours, modern flooring, nicely appointed bathroom(s) and kitchen facilities and lack of clutter will all be positive features, as will the absence of a need for major repairs required and the fact that all prior renovation projects are complete (for example, that last piece of trim, or the light fixture in the laundry room).
In what situation would a renovation be a detriment to a potential buyer down the road?
DW: Extensive personalization of the home with respect to layout or colours. For example, in a neighbourhood where most homes have double-garage facilities and market participants are looking for garage facilities, extensive renovations converting the garage to a ‘man cave’ or fitness facility may not provide any return. In terms of colours, you may love the hot pink wall colour in the master bedroom or the sea foam green carpets in the bathroom, but potential purchasers are looking at the home with dollar signs for costs to renovate floating through their minds.
What are some of the small renovations you find yourself recommending the most, if homeowners want to sell their homes down the road?
DW: Generally, items such as landscaping and painting will have the highest returns, followed by kitchen, bathroom and flooring upgrades.
Do you have any general advice for Canadians who are considering a renovation?
BC: Get it in writing. Do your homework to find a company that you feel comfortable with. Vet them to ensure they are licensed, insured and are experienced doing the type of project you are looking to undertake. Furthermore, ensure the clients they did this type of project for were happy. Don’t be afraid to ask questions and document details of the project and responses to ensure you have clear details to refer back to in the event of a dispute. Remember it takes two to tango, and the success of this homeowner-contractor relationship is like a marriage. You are not buying a cell phone, you are working with a person to improve your home, and it may be a yearlong process. If you are not going to do the work yourself, I recommend starting at your local home builders association to find nationally recognized Renomark Approved contractors that all abide by a strict code of conduct and ethics and are all focused on running their businesses and working for their clients as professionals. Visit www.renomark.ca to find out more.
FH: A renovation can be a smart and affordable way to upgrade your home. It can make your home more livable and comfortable for you, but in order to truly relax you need to keep your renovation on budget. Before starting a project, do your research on costs and build a buffer into your budget for any unexpected expenses. Finally, ensure you are aware of any bylaws of your local city/municipality before you undertake any major home renovation projects.
DW: Carefully consider your motivations for renovating – are you renovating to sell the home at a higher price or in a quick time period? Or are you renovating because you want to remain in the home and are looking to increase your enjoyment of it? With that in mind, consider your proposed renovation carefully and keep in mind both the trends in the market (are prices going up, down, stable?) and within your neighbourhood (where does your home sit in the neighbourhood in terms of price levels – high end, low end or average?). If your home is already at the upper end of the price range for your neighbourhood, you have to consider whether you will realistically be able to get your money back. Appraisal Institute of Canada members live and work in most areas of the country. They are in literally thousands of homes each day. If you are considering a renovation for your home and are unsure of the potential payback or return on investment, contact an Appraisal Institute of Canada member with a CRA or AACI designation.
MD: In deciding what to renovate, I think you need to balance the resale value of the work you undertake with a sense that if you make decisions based solely on what you perceive other people will buy you will never fully feel at home – you’ll be living in someone else’s home. I don’t recommend ridiculously quirky renovations, but at the end of the day I won’t argue with you about your aesthetic decisions, or what your priorities are. In customizing a home, you run the risk of functionally or aesthetically tailoring it to fit you, and chances may be that it will reduce the number of people who would buy it for themselves. Factor in how long you plan to live there, and how much you will enjoy the renovation for that period, not just in what you would get back out of it. In the end, get good advice, weigh that advice against your own priorities, and proceed in as balanced a manner as you can. Everyone will tell you that statistically you will get the most return on your investment from renovating your kitchen and bathroom. But what if your bedroom drives you crazy and needs to be re-organized first? Or what if you hit your head every time you go up the stairs? In the end, quality of life doesn’t get reflected in only a dollars-and-cents view of things.
Things to Consider When Looking for a Contractor
Dave Minor, vice-president, TD Insurance, offers his top tips to homeowners on how to protect their biggest investment during renovation season this year:
Check your insurance policy – While it’s exciting to get the wheels in motion for the kitchen or basement of your dreams, the first call you should make is to your insurance provider to ensure you have adequate coverage during the renovations. For example, some homeowners may not be covered if they vacate their home for a certain amount of time. Don’t forget to let your insurer know of any upgrades, too.
Consider your renovations – A marble countertop in your kitchen may be high on your list, but consider renovations that will not only increase the value of your home, but also save you money on your home insurance. For example, installing a home security system can reduce your premiums, and upgrading your basement to ensure it is watertight can save you from expensive headaches down the road.
Do your homework on your contractor – Your contractor should have general liability insurance, which will protect your home from damage or negligence from the contractor or anyone they hire to work on your property.