If our passion for television show The Block is anything to go by, Australians like to renovate (or watch other people renovate). Many of my clients are joining an army of renovators and I can sympathise as my wife and I have just completed a kitchen renovation while expecting our second child.
If you are wanting to make some serious changes to your house, what is the best strategy?
Borrow to build
While many people borrow money to renovate, it can increase non-deductible debt. Renovations on your home are not tax deductible. For example, if you were to re-draw $40,000 against your home loan at current interest rates of around 4.50 per cent and assuming there are 16 years left on your principle and interest home loan, the interest and principle loan repayments will total $56,185 and your $40,000 kitchen renovation will actually cost $56,185.
Save your pennies
You could save $40,000 and start your kitchen renovation when you have the cash. This is the obvious option but for many people it means having to wait quite some time to be able to save the necessary amount.
Use a loan offset account
The third option, and the one that I’ve gone with, is keeping my cash in my home loan offset account and taking advantage of the interest-free purchase plans offered by some kitchen manufacturers and appliance retailers.
I have the cash saved for a renovation through good budgeting and control of my cash flow using an automated budget software tracking program.
How does this work? For example, the kitchen manufacturer will provide a $30,000 interest-free loan with monthly repayments of $833 over 36 months. This does cost $540 more per month than borrowing money from a bank but it does result in an additional $30,000 sitting in the offset account.
The appliance retailer will provide 50 months’ interest free with nothing payable until the end of the 50 months. Knowing that the monthly repayments can comfortably be paid to the kitchen manufacturer, having the $40,000 sitting in your offset account will save $6,300 in interest over the next five years assuming a constant interest rate of 4.50 per cent on an interest-only home loan.
At the end of the three years, all of the payments to the kitchen manufacturer are finished and after five years there is cash sitting there ready to pay the appliance retailer. There is still $30,000 cash available for something else.
To make this work, you need the discipline not to spend the $40,000 on something else, but it does mean that a $40,000 kitchen renovation is now costing $33,300 by smartly managing cash flow. It’s a nice balance to have the kitchen renovation now but still have a large cash buffer on hand. If need be, the cash can be used to pay the suppliers at any point in time.
Things you need to be aware of include missing a monthly payment or not paying out the amount in full at the end of the interest-free period. This will often result in high interest rates being applied to the balance due (up to 20 per cent interest rates). There may be penalties for early repayment and obtaining interest-free finance may restrict your capacity for other loan applications. You need to make sure you read the terms and conditions of the interest-free finance agreement. Also, some suppliers do provide a discount if you pay upfront in cash. Keep that in mind too.
To conclude, any home renovation involves a large commitment of money and time. Having a disciplined approach to how you manage your cash to fund a renovation, combined with the right use of loan products and purchase offers from suppliers, can achieve a smart financial result. For me, the above approach means we have more cash in our offset account against our home loan saving non-deductible interest repayments. We still have access to cash in case of an emergency.
The above strategies use these financial tools (interest-free purchase plans and offset accounts) to your advantage. Using financial tools such as interest-free purchase options on their own often ends in financial disaster for consumers. Ultimately, applying financial discipline and having a clear strategy will achieve better financial outcomes.
Andrew Zbik, senior financial planner, Omniwealth