What are Renovation Loans and How Do They Work?

A renovation loan allows you to borrow additional funds on top of your existing mortgage to complete improvements to your property.

For Bentleigh residents, where character homes and period properties are common along streets near Centre Road and around the Patterson Station precinct, renovation lending has become a practical way to modernise older homes without needing to sell and relocate. Rather than saving for years before starting work, a renovation loan lets you access equity in your property now and fund the project as construction progresses.

Equity Release Through Refinancing

Releasing equity means refinancing your existing mortgage to borrow against the increased value of your home. If your property is worth $1,200,000 and you owe $600,000, you have $600,000 in equity. A lender will typically allow you to borrow up to 80% of the property value without incurring Lenders Mortgage Insurance, which in this scenario means you could access up to $360,000 for renovations while maintaining that 80% loan to value ratio.

This approach suits homeowners who have owned their property for several years and benefited from value growth. Refinancing to release equity can also be an opportunity to secure a lower rate or switch to a loan structure that better suits your current circumstances. Lenders assess the application based on the proposed renovations, your income, and the expected value of the property once works are complete. A valuation will be required, and in some cases, the valuer will provide an 'as if complete' valuation that estimates the property's worth after the renovation.

Construction Loans for Major Renovations

A construction loan is structured differently to a standard mortgage. Funds are drawn down in stages as the build progresses, known as progress payments. You pay interest only on the amount drawn, not the full approved loan amount, until construction is complete.

Consider a homeowner in Bentleigh undertaking a two-storey rear extension and full kitchen renovation at a cost of $280,000. The lender approves a construction loan with five progress payments aligned to milestones such as slab pour, frame completion, lock-up, fixing stage, and practical completion. At each stage, the builder provides documentation, the lender arranges an inspection, and the next portion of funds is released. Once the project is finished, the loan converts to principal and interest repayments at the agreed rate.

This structure gives both the lender and the borrower confidence that funds are being used as intended. It also reduces the immediate repayment burden during construction, which can last several months depending on the scope of work.

Offset Accounts and Renovation Funding

If you hold substantial savings in an offset account linked to your mortgage, those funds can be used to pay for renovations without needing to increase your loan amount. The advantage of keeping savings in an offset account rather than a standard transaction account is that the balance offsets the interest charged on your mortgage, reducing the cost of your loan over time.

Using offset funds for a renovation means you are effectively self-funding the project while still maintaining the tax and interest benefits associated with the offset structure. Once the renovation is complete and the property has increased in value, you can choose to rebuild your offset balance or, if needed, refinance to restore liquidity. This method works well for owner-occupiers who have built equity over time and prefer not to increase their debt.

Split Loan Structures During Renovations

A split loan divides your total borrowing between fixed and variable portions. During a renovation, this structure can provide stability on one portion of your debt while allowing flexibility on the other.

In a scenario where a Bentleigh homeowner borrows an additional $200,000 for a renovation, they might fix $150,000 of their existing loan to lock in repayments during the construction period and keep the remaining balance, including the new borrowing, on a variable rate. The variable portion allows access to an offset account and gives the flexibility to make extra repayments without penalty. Once construction is complete and finances stabilise, the borrower can reassess the split and adjust the structure if needed.

This approach balances certainty with adaptability, which can be valuable during months when renovation costs or timing shift unexpectedly.

Loan to Value Ratio and Borrowing Capacity

Lenders calculate how much you can borrow for a renovation based on your loan to value ratio and your ability to service the higher debt. If your LVR is already above 80%, you may need to pay LMI on any additional borrowing, or the lender may decline the application altogether.

Borrowing capacity is assessed using your income, existing debts, living expenses, and the interest rate buffer required under lending policy. Even if you have sufficient equity, the lender must be satisfied that you can afford the repayments on the increased loan amount at a rate at least 3.0 percentage points above the product rate. Where serviceability is tight, some borrowers choose to use a combination of savings and borrowed funds rather than financing the full renovation cost.

A loan health check before starting a renovation can clarify how much you can comfortably borrow and whether your current loan structure is the most suitable for the project ahead.

Applying for a Renovation Loan

When you apply, the lender will require detailed information about the scope of work. This typically includes builder quotes, architectural plans, council permits where applicable, and a schedule of costs. For a construction loan, a quantity surveyor's report or a fixed-price building contract may also be required.

Lenders assess renovation applications more carefully than standard purchase loans because the security property is subject to works that temporarily reduce its value or marketability. Approval depends on the quality of documentation, the borrower's financial position, and the lender's appetite for construction-related lending at the time of application.

For homeowners in Bentleigh, where renovations are common and the local market is well understood by valuers and lenders, the process is generally efficient provided the documentation is thorough. Engaging a broker who understands construction lending can reduce delays and improve the likelihood of a smooth approval.

Owner-Occupied vs Investment Property Renovations

The loan structure and interest deductibility differ depending on whether the property is your home or an investment. For an owner-occupied home loan, interest on borrowings used for renovations is not tax deductible. For an investment property, interest on funds borrowed to improve or maintain the property is deductible against rental income.

If you are renovating an investment property in Bentleigh, keeping clear records of how borrowed funds are used is necessary for tax purposes. Mixing personal and investment expenses on the same loan can complicate deductions, so separating the borrowing or using a dedicated loan split for the renovation is often recommended.

A broker can help structure the loan in a way that aligns with your tax position and minimises complications at the end of the financial year.

Renovating your home is a significant financial and personal commitment. Choosing the right loan structure, understanding your equity position, and working with a lender that supports construction-related lending will give you confidence throughout the project. Call one of our team or book an appointment at a time that works for you.

Frequently Asked Questions