How Do Home Renovation Loans Work?

by | May 19, 2024 | Refinancing

Embarking on home renovations can be both exciting and daunting. As you dream up the perfect space, it’s important to consider how you’ll finance your project. Home renovation loans are a popular option, offering a structured way to fund your renovations.

With various loan options available, understanding the difference between home renovation loans and other borrowing options is a superb place to start.

Home renovation loans are similar to unsecured personal loans. In this post, I’ll expore how do home renovation loans work, and compare them against other types of finance so you can make an informed decision.

How Do Home Renovation Loans Work?

Home renovation loans are a form of financing that specifically cater to home improvement needs. They allow you to borrow money for renovating your property, enabling you to enhance your living space without depleting your personal savings. The borrowed funds, plus interest, are repaid over a set period.

Home renovation loans are a little like personal loans. They are shorter than a standard mortgage, and attract a higher interest rate.

Loan amounts typically go up to $50,000, with interest rates and terms varying based on your creditworthiness and other factors. Most lenders offer home renovation loans over 7 years, some may extend out to 10 years.

Pros of Home Renovation Loans

  • Faster access to funds
  • No need to use home equity
  • Fixed or floating interest rate options

Cons of Home Renovation Loans

  • Higher interest rates
  • Limited borrowing capacity (usually up to $50k)
  • Shorter loan terms (limited to 7 years)

Home Renovation Loans vs Leveraging Existing Mortgage

When it comes to financing home renovations, you’ve got a couple of choices: take out a specific renovation loan or draw additional funds from your existing mortgage.

A standalone renovation loan is separate from your mortgage, and usually carries a higher interest rate, making it costlier over the long haul.

For instance, a project financed at the common personal loan rates of 12% to 14% would incur significantly more interest than the 3% to 4% typically charged on a mortgage from providers like ANZ or Westpac.

Options for Home Renovation Loans

1st or 2nd Mortgage

In New Zealand, a 1st or 2nd mortgage for home renovations uses your home’s equity as collateral to secure a loan for financing home improvement projects.

A 1st mortgage is the primary mortgage you have on your home, while a 2nd mortgage is an additional loan taken out using your home’s remaining equity as security.

A 2nd mortgage allows you to access more of your home’s equity than you could with just your 1st mortgage. However, a 2nd mortgage often has a higher interest rate than a 1st mortgage, as it is considered riskier for the lender.

Home Equity Loans

A home equity loan in New Zealand is a type of loan where you borrow money using the equity in your home as collateral. Equity is the difference between the market value of your property and the amount you still owe on your mortgage.

You can borrow a percentage of this equity, typically up to 80% of the home’s value, and use the funds for various purposes such as home renovations, debt consolidation, or investment. These loans often have lower interest rates than personal loans or credit cards.

Line of Credit

A line of credit mortgage, also known as a revolving credit mortgage, is a type of home loan that functions similarly to a credit card or overdraft facility.

With a line of credit mortgage, you have access to a pre-approved borrowing limit that you can tap into as needed, rather than receiving a lump sum upfront. You can withdraw and repay funds flexibly, only paying interest on the amount you’ve borrowed at any given time.

This type of mortgage can be useful for managing cash flow and financing ongoing expenses or home renovations. It requires strict budgeting however, to ensure you pay down the principle and interest.

Cash Out Refinance

A cash-out refinance allows you to borrow against the equity in your property and receive cash at settlement. This can then be used for home renovations.

Home Loan top Up

Alternatively, if refinancing isn’t suitable, a loan top-up could be an option if your lender offers it. This means increasing the amount borrowed from your existing mortgage and spreading the cost over the remaining loan period, which can make repayments smaller and more manageable over time.

Construction Loans

For major renovations, such as house extensions a construction loan might be a better option.

According to the search results, a construction loan is a type of loan that can be used to finance either the construction of a new home or major home renovations in New Zealand.

For home renovations, a construction loan works as follows:

  1. Approval process: The lender will evaluate your renovation plans, budget, and creditworthiness to approve you for the construction loan.
  2. Funds disbursement: Instead of receiving the full loan amount upfront, the lender will disburse funds in increments as the renovation progresses, based on inspections and completion of work.
  3. Short-term nature: Construction loans for renovations are typically short-term, lasting 6-12 months, after which you may need to refinance into a traditional mortgage.
  4. Higher interest rates: Construction loan interest rates are usually higher than standard mortgage rates due to the additional risk.
  5. Interest-only payments: During the construction phase, you typically only pay interest on the loan, with the full principal payment due at the end of the term.

Construction loans are often used for new builds, but can also be used for home renovations. The key difference is that for renovations, the lender is assessing the value of the completed project rather than the value of the land and new construction.

Other Finance Options

Exploring different ways to fund your home renovations could save you from the higher costs of traditional loans. Consider using a credit card for renovations under $5,000, as some cards offer lower interest rates than loans, making this a smart choice.

Long-term finance cards, like a Q Card or GEM Visa, can be advantageous if you’re purchasing renovation materials or services from retailers that offer several months of interest-free financing. Be sure to repay the balance before the promotional period ends to avoid high-interest rates, which can exceed 25% per annum.

For a more affordable approach, applying for a low-interest credit card could be a viable solution, allowing you to make purchases and manage repayments more flexibly.

Personal Loans and Credit Lines

For smaller renovations, a personal loan provides a fixed amount of money with a repayment period that typically ranges from one to seven years. Personal loan rates can vary, often based on creditworthiness, and they’re usually higher than home equity options since they’re unsecured.

Credit lines, including credit cards, can be used for purchasing materials or paying contractors. Credit cards are convenient and may offer rewards, but come with higher interest rates. It’s a good option for quickly accessible funds and short-term borrowing, but be wary of the high costs if the balance isn’t paid in full promptly.

Eligibility and Requirements for Home Renovation Loans

Before you dive into the process of securing a home renovation loan, you need to understand the specific criteria lenders use to assess your application. Your credit score, financial stability, and the equity you have in your property all play roles in this journey.

Credit Score Considerations

Your credit score determines your eligibility for a home renovation loan. Most lenders look for a credit score that’s typically above 600, with higher scores improving your chances of securing lower interest rates. A strong credit history without significant defaults can be influential in the approval process.

Income and Financial Standing

Lenders will assess your income and financial standing to ensure you can manage the loan amounts agreed upon. They’ll consider your employment stability and your debt-to-income ratio, which ideally should be under 36%. Regular savings deposits can illustrate financial discipline, making you a more attractive candidate for an equity loan.

Collateral and Equity

If you’re seeking a home renovation loan from a bank or another lender, they’ll often require collateral in the form of your home’s equity. The amount you can borrow often depends on how much equity you’ve built up; generally, the more equity, the larger the potential loan amount. Equity is calculated by estimating the value of your property minus any outstanding mortgage dues.

Assessing Your Financing Needs

Before you dive into your home renovation project, it’s vital to have a clear understanding of your financial requirements. Whether you’re planning a kitchen makeover, adding an extra bedroom, or upgrading your bathroom, setting a realistic budget and evaluating the financing options available to you are crucial steps.

Determining Your Renovation Budget

Creating a detailed budget for your renovation is the first step to ensure you can align your project plans with your financial capacity. Start by breaking down the costs for each aspect of your renovation. For a kitchen revamp, consider the expenses for cabinetry, appliances, and labour.

A bathroom remodel can vary in price depending on tile choice and fixtures. Remember, unexpected costs may arise, so include a contingency of at least 10-20% within your budget. This foresight will provide a buffer for any surprises.

Cost-Benefit Analysis

Consider the long-term benefits and potential increase in property value when deciding on the scale of your renovation. Will an additional bedroom offer a significant return on investment? Is upgrading to high-end finishes in your kitchen or bathroom going to enhance your lifestyle and home value?

Weigh the expected benefits against the costs to determine if the renovation will achieve the outcomes you desire.

Loan Amounts and Repayments

With your budget in place, you’ll need to evaluate how much you need to borrow. The loan amount should cover the total renovation costs, including labour and materials.

You’ll need to consider the loan term and decide whether you prefer lower monthly repayments over a longer period, or if you’re comfortable with higher repayments in exchange for a shorter loan term.

Be wary of opting for a large lump sum if it’s going to stretch your finances thin. Use a loan calculator to estimate your regular repayments before committing to a loan.

Choosing the Right Financing Option

Our mortgage brokers will help you explore the different financing options available. We’ll help you evaluate the associated costs, repayment terms, and how these fit into your overall financial situation.

The Renovation Loan Application Process

Documentation and Preparation

To kick off your application, you’ll need to gather all the necessary documentation. This typically includes proof of income, employment history, a list of assets and debts, and perhaps a detailed plan of your renovation project.

Your bank or lender will require these documents to assess your ability to make monthly payments and to determine the loan term.

Working With a Mortgage Broker

Our mortgage brokers really are invaluable when it comes to home improvement loans. We shop around for your loan to find one that suits you at a competitive rate.

We then ensure your application is well-presented and meets all criteria set by the lenders, putting your best foot forward for successful approval fast.

Loan Approval and Disbursement

Once you’ve submitted your application with all required documentation, your bank will review it for approval. This phase includes an evaluation of your financial health, the anticipated settlement costs, and the long-term feasibility of the loan term.

Upon approval, the loan funds will be disbursed to cover the costs of your renovations, allowing you to transform your space into your envisioned home.

Drawing Funds and Making Use of Them

With a drawdown facility, you have the flexibility to withdraw portions of your loan as needed for your renovation project. Be sure to communicate regularly with your lender to release funds in alignment with your project’s progress. Always check that your withdrawal aligns with the renovation stage, as premature drawdown can incur unnecessary interest.

Monitoring Your Budget and Costs

Keep a close eye on your budget and actual expenditure. Create a detailed budget tracker and update it with every purchase or contract payment. Keeping this information up-to-date will alert you to any potential overruns before they become a problem.

Utilise a redraw facility if you’ve made additional repayments earlier, but remember it should be used judiciously to avoid extending the loan term.

Here is a budget tracker example:

StageAllocated BudgetActual CostVariance

Repayment Strategies

While undergoing the renovation, don’t lose sight of your repayment plan. Consider options like incremental repayments to even out financial pressure or lump-sum repayments if you expect a surplus of funds later. Remember, the sooner you repay your home renovation loan, the less interest you’ll pay in the long run.


When exploring home renovation loans, you have access to a variety of finance options. It’s essential to weigh these against your long-term goals and current financial situation.

Consider the equity in your home; it can be a valuable asset when thinking about updates. Using your equity wisely could potentially offer a more cost-effective way to finance your renovations.

Planning for the future is key. Renovations should not only meet your present needs but also add value to your home. Well-thought-out changes can enhance your living space and potentially yield a good return on investment.

If you’re leaning towards a home renovation loan, take note of the different stages at which funds are disbursed, as this will affect your budgeting and project planning. Remember, with organised finances and a clear plan of attack, your renovation project can run smoothly and efficiently.

Chat to a Financial Adviser About a Home Loan (No Cost, No Obligation)

decorative line

Please complete your contact information and one of our specialist New Zealand mortgage brokers will be in touch.