Reality cheque
Jane-Anne Lee, Sun Herald, 14th of May 2006
THE IDEAL home renovation achieves the look you desire at a price you can afford. So before you rush to rip down a wall, renovate the bathroom or embark on a whitegoods spree, you need to explore all your funding options.
While you may be tempted to snap up a store's interest-free deal, where you buy now and pay later, or use the equity in your home to finance renovations, remember you may be paying for it for a long time afterwards.
There are plenty of traps if you don't do your homework or absorb the fine print on contracts, warns Elizabeth Terry, a financial counsellor at Wesley Counselling Services. She advises home renovators to draw up a budget, examine the pros and cons of each funding option and not to rule out a personal loan or saving before paying.
Financing a renovation
Redraw
If you have a redraw facility with your home loan, and you are ahead with your mortgage payments, you can use the equity in your home to fund your renovation. With interest rates on standard variable loans at 7.57 per cent, this is a cheaper option than a personal loan at 10-12 per cent.
Say you have made $50,000 in extra payments, then you can redraw up to this amount to pay for your renovation. You can also top up or extend the term of your loan.
Financial planner Paul Moran, of Cameron Walshe Financial Planning, Melbourne, says it's important to increase the repayments on your home loan to pay off the extra borrowing quickly.
"Say you borrow $20,000 to upgrade a bathroom. If you kept paying normal repayments on your 25-year home loan, you are paying interest on that $20,000 for the next 25 years. You'll end up paying $28,000 in interest so the bathroom will cost $48,000 for a $20,000 upgrade," he says.
"But if you increased your repayments to, say, an extra $6666 a year so that your loan amount was paid off in three years, you would have only paid interest of $4200."
Mortgage offset
While saving up for your renovation you can reduce interest charges on your mortgage at the same time with a mortgage offset account. This is basically a deposit account linked to your mortgage where the balance on your mortgage offset account is offsetting debts on your mortgage.
If you put $20,000 in your mortgage offset account and the original mortgage is $200,000, the actual interest accruing on your debts is from $180,000.
But these loans come with a higher interest rate because they are fully featured, says Garfield Wright, a financial analyst at research house Cannex.
Personal loan
If you don't have equity in your home, sufficient funds in your savings account or you lack self-discipline, then a personal loan may be an option.
You'll need to prove you have the cash flow to pay off the interest and the loan in a specified period, usually five to seven years, says Harry Senlitonga, also a financial analyst at Cannex. The downside is the interest rate is higher - about 10-12 per cent - compared with your standard variable housing loan of 7.57 per cent.
Now for the spending spree
Interest-free deals
If you're the disciplined type, then the popular, interest-free campaigns by major retailers can be a good way to finance home purchases, such as plasma TVs, whitegoods and furniture. But if you fail to pay all that's owing by the due date, you'll be stung by an interest rate of up to 27.99 per cent.
The biggest market player for interest-free is GE Money, whose products extend to more than 10,000 retailers.
Greg White, managing director of retail finance at GE Money, says there are two types of interest-free. The first is known as buy now, pay later. There is no deposit required, no interest charged and no payments for generally between 12 and 18 months. At the end of the term, an interest rate of 27.99 per cent applies to any outstanding balance.
The second type is known as interest-free where you have a balance that is interest-free but there is a monthly payment required to reduce the balance. The usual term is 24 months. "If customers choose to extend, the interest rate is 27.99 per cent," White says. "But the majority of our portfolio don't pay interest," he says.
White believes interest-free is one of the cheapest forms of finance available. "Its distribution is significant and it's well understood, and that is backed up by statistics showing that 60 per cent of our business is people coming back.
"We don't hide behind the 27.99 per cent interest rate, but the vast majority of our portfolio doesn't pay interest. None of these products backdates interest."
You can make interest-free purchases at any one of the 10,000 retailers that
stock GE's products with cards such as CreditLine, Buyer's Edge and GO MasterCard, a joint venture with Harvey Norman, which has a credit card facility and a retail finance capability.
"Once you have been approved for one of these cards, if you want to do a second purchase all that is required is authorisation," White says. "You can use one promotion to buy a couch at one store and a plasma screen at another, as long as you are within your credit limits."
But Moran warns there is no such thing as interest-free.
"Someone has to be paying interest on the money and, in most cases, it is the seller. Therefore you may pay a higher price for the goods.
"Also, because there is deferred payment, it's difficult to identify the impact on your budget that far in advance.
"For people who have a variable component to their income, such as commissions or bonuses, they may be factoring that into their income at the time of purchase. That may disappear at the very time they need to start making payments.
"We have heard of people who have paid off all but a very small amount by error. Because the loan hasn't been paid off, the fine print says interest will apply to the whole balance for the whole term.
"I would suggest that people get written confirmation from the lender that the loan is paid off completely before expiry of the interest-free period."
Own it now
Closely resembling hire purchase, with own it now you make interest-bearing payments, usually monthly, for a fixed period of time.
At the end of the period, provided you have met all your payments, your balance will be zero. With GE Money, the interest charged with own it now is 19 per cent.
Wright describes own it now as a "dinosaur of a product".
"If you stick to the same payment schedule, you'd be better off putting it on your credit card because the interest rate is likely to be less so you will pay it off faster."
Savings tips
Rather than borrowing, or being tempted by interest-free deals, you could try simply saving the money instead. Here are some tips to get you started:
- Draw up a budget with all your expenses and debts
- Make some simple adjustments. For example, buy one less takeaway each week
- Make a list of your spending priorities
- Make sure your savings are in a high-interest account
- Deposit money directly from your earnings into this account
- Consider a part-time job to supplement your savings
- Rotate sacrifices. For example, go without cappuccinos one week, take lunch to work the next
The winning scenario
You're buying two leather sofas for $3000 each, but what's the best way to pay for them?
Renovation loan
If you use a redraw or top-up facility and you pay the amount back within 36 months, it will cost you $185.26 each month on top of your required repayments. Total cost: $6669.45.
Personal loan
If you take out a personal loan for three years at an interest rate of 10 per cent, each month you'll pay $193.60. Total cost (provided you meet all your payments): $6969.
Interest-free
If you take out a 36-month interest-free agreement, you will pay $166 every month.
You will pay back just $6000 plus $99 in account-keeping fees ($2.75 a month for 36 months). Total cost: $6099.
Own it now
At an interest rate of 19 per cent, this will cost $219.94 a month. Total cost after three years: $7,917.70.
And the winner is ... Interest-free
