Di Johnson, Griffith University
Australia’s appetite for home renovations remains strong, with around A$1 billion worth of home modifications and additions approved in July.
But rising interest rates and labor and material shortages may have some would-be renovators wondering: Is this still a good idea?
Here are five questions worth thinking about.
1. What would a successful renovation look like – before, during and after?
As with any major financial decision, you need to understand how the renovation fits into your larger life goals. Why do you want to do it?
There is a big difference between a “nice to have” new kitchen and a “must have” modified bathroom for mobility needs.
Let’s say you choose rather than having to renovate.
Consider whether the election is for capital gain on short-term sale (up to five years). Flipping a property will incur transaction costs such as stamp duty and legal fees, so factor this into the overall cost. Can you still afford it?
Or are you looking to live in the house longer term? Will the renovation provide a pleasant lifestyle for many years? For some, it may be worth the financial belt-tightening.
It’s not just about capital gain, increased floor space, amenity or privacy.
A renovation affects areas of life satisfaction beyond finances – including family life, relationships, work, health and lifestyle opportunities such as being able to afford to travel.
2. Have you calculated the sums?
You can get quotes from designers or builders. Check the detail, including allowances for budget variations. Consider whether certain changes, such as solar power, good insulation and energy-efficient design, can reduce bills over time.
You can use the government’s online Moneysmart calculator to calculate how much your payments will increase on a larger mortgage after paying for renovations.
Let’s say you have a 25-year mortgage and are considering a $150,000 renovation. This can cost you around $10,000 more per year in mortgage payments, especially if interest rates were to drop from a variable rate of 3.5% currently to 5.5% over the next few years.
This $10,000 would be in addition to increasing repayments on your existing mortgage, which (on the average new Australian mortgage of around $610,000) could be around $8,500 extra if rates go up two percentage points.
3. What risk can you bear?
If you suffered a sudden shock to your income, expenses, or health, how long could you cover all of your expenses without having to sell major assets or go without commodities?
This can depend on a range of factors, including whether you have income protection or other insurance, and whether you have a savings reserve.
An indicator of your risk is your debt-to-income ratio (total debt divided by annual pre-tax income, excluding mandatory pension contributions).
Lenders and regulators consider a ratio above six to be high. However, 23.1% of borrowers in the March 2022 quarter had a ratio of six or more.
Your personal debt comfort zone could be much more conservative. Only you will know how much debt you can handle before it stresses you out so much it isn’t worth it.
If you’ve determined that your entire project is too risky at this time, you might consider doing the renovation in stages. But while this may get you a smaller mortgage in the short term, it may cost more in the long run and lengthen the time frame.
What if you have already had plans drawn up and obtained approvals from an architect or designer, but you no longer wish to renovate? You might consider selling the house with the plans approved; it remains a good value-added option.
4. What expert advice can you get?
Seeking expert advice from architects, designers, landscapers, builders, or project managers before and during the renovation can help you get better value, less stress, and fewer errors in the renovation. ‘together.
Word of mouth recommendations can help, but also check the Master Builder Association listings and ratings for builders.
It is essential that you exercise due diligence regarding the quality, reliability, creditworthiness, style, insurance and cost of the experts you hire.
This may include seeking advice from an expert building and construction lawyer to check the contract before signing it.
Choose someone who is easy to talk to, listens, and understands your goals. The relationship with your construction and design team will be crucial.
5. What role do my emotions play?
Almost every episode of reality shows about renovation seems to feature an emotional breakdown and a massive budget blowout.
Emotions are an important consideration throughout your renovation. Financial decisions are never just about money.
If maintaining relationships and a healthy stress level are part of what a successful renovation looks like for you, plan ahead.
If that means moving into a rental for the renovation period, add that to budget considerations.
Renovating can be exciting and exhausting, but beware of some common renovation decision biases.
One is the sunk cost fallacy, where the time and money you’ve invested in the project so far can make it difficult to change or abandon plans.
Even paying a small deposit can lead to irrational reluctance to change course.
Then there is decision fatigue, where mental energy runs out with every decision (and there is a plot). It becomes tempting to give in to what seems easiest at the time.
Be prepared to take extra time to consider high-stakes decisions and seek advice, especially in areas where you have no experience. Getting the right advice at the right time for a renovation could be one of the most important financial decisions you can make.
Di Johnson, Lecturer in Finance, Griffith University
This article is republished from The Conversation under a Creative Commons license. Read the original article.