Using interest free finance wisely for home renovations

From

Andrew Zbik

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,

So, 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% and assuming there are 16 years left on your principle and interest home loan, the interest and principle loan repayments will total $56,185. So, your $40,000 kitchen renovation will actually cost $56,185.

Save your pennies

You could save $40,000 and then start your kitchen renovation. This is the obvious option but it means for many people that we now have ’opportunity cost’ of having the new kitchen renovation now with the additional cost through borrowing money or waiting some time and paying cash.

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 (Good budgeting and control of cash flow is the result of using an automated budget software tracking program like Moneysoft).
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%pa 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 payout the appliance retailer. There is still $30,000 cash available then for something else.

To make this work you need the discipline not to spend the $40,000 for something else, but it does now 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 payout 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% 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 do pay upfront in cash. So 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. We can also pay out the suppliers if need be.

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 so often ends in financial disaster for consumers. Ultimately, applying financial discipline and having a clear strategy will achieve better financial outcomes.

By Andrew Zbik, Senior Financial Planner

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