An extension loan could well be a prerequisite of adding extra space to your home without having to move house in 2023. Extensions can unlock the potential in an existing home, and with the right planning and design advice, they can also potentially add value to your property.
Homeowners have a raft of finance options available when building an extension. Adding the borrowing to existing mortgage debt or taking out a loan are obvious choices, but there are plenty of alternatives too.
“There’s no single approach that’s right for everyone, so it’s worth understanding the benefits and drawbacks of each approach, so you can work out the right one for you,” adds Sarah Coles, personal finance expert at Hargreaves Lansdown.
This guide will take you through the options and some of the key pros and cons, to help you decide what could be the right route for you.
1. Forget extension loans — use savings
You may not need an extension loan at all — if you have savings, using this cash to pay for your house extension can make sense. It’s straightforward and there will be no third-party involvement or interest to pay.
Kevin Mountford, savings expert at Raisin UK, says: “One of the many benefits of using cash savings is that it can speed up the process from getting contractors to completing the project, without having to wait for bank approval and loans to enter your account. Similarly, it will lower your costs overall for the extension as unlike a loan, you won’t have to pay back any interest on your loan.”
But using your savings is a big decision and it’s generally unwise to run your cash reserves down to zero. So it's important to establish how much your extension costs, including a minimum 10% contingency for any unforeseens, will be before work starts on your building project.
2. Remortgage to fund your extension
Remortgaging, by switching mortgage deals and borrowing more money to cover the cost of the extension, enables you to shop around for the best mortgage product on the market.
“If interest rates are low, and your existing mortgage rate is relatively high, it can also be a cost-effective way of organising funding,” says Mark Harris, chief executive of mortgage broker SPF Private Clients. “However, the opposite is true if rates are rising — if your existing mortgage is on a low rate, you may wish to hold onto it, rather than remortgaging the whole amount to a new, higher product.”
This may be the case at present, as house prices begin to drop from 2022 highs and mortgage rates rise.
You’ll need sufficient equity in your home to remortgage for a higher amount. For example, if your home is worth £300,000, and your current mortgage is for £150,000, you could remortgage for £200,000 and use the £50,000 for home improvements.
If early repayment charges on your current mortgage would make a remortgage too expensive, you could borrow more money from your current lender in the form of a ‘further advance’. This will be at a higher interest rate than your mortgage and will also be secured on your home.
If you remortgage to release equity, you’ll need to undergo a full affordability assessment so be prepared to provide payslips and bank statements.
4. Consider a home improvement loan
‘Extension loans’ or ‘home improvement loans’ are personal loans marketed at homeowners who have equity in their property.
“The amount of equity you have in your home is the portion of your home you’ve already paid off,” explains Mountford. “On average, home equity loans carry lower interest rates, but your home is collateral for the loan and if you miss repayments, your house can be repossessed.”
You can often borrow six-figures sums as secured loans or second charge mortgages, to fund a large double storey extension for instance, assuming you have enough equity. This can be the case even if you have a poor credit history.
But think carefully about how much you could afford to pay back each month. For example, if you borrow £100,000 over 20 years at 5.7% interest, you’ll pay back £693.22 a month. This makes the total interest £66,373 assuming the interest rate stays the same.
Unsecured loans are usually more expensive but are less risky for the borrower. You can normally borrow up to £25,000 on an unsecured loan but you’ll need a good credit score. Interest rates can be anything from 5 or 6% to sub-prime rates close to 50%.
As an example, you might be eligible for a best buy personal loan from M&S Bank at an interest rate of 5.5%. If you borrowed £20,000 over five years, you’d repay £381 a month and repay a total of £22,847.
The latter might be an option if you're hoping to build a budget extension or a more modest, smaller-scale extension, or need to top up savings to complete a larger build.
4. Apply for a dedicated stage payment mortgage
Stage payment mortgage issue funds in stages, either in arrears or advance, for large-scale building projects. The money lent will either be based on your costs, or dependent on an uplift in value at each stage.
Self build mortgages work in this way, but this can also be an option where the house you have purchased isn't habitable, potentially making high street lending difficult to secure, for instance.
This type of mortgage is available from specialist lenders such as Buildstore and Buildloan, as well as some high street lenders. It’s best to use a broker to find the best stage payment mortgage for your project and financial situation.
Stage payment mortgages are likely to need building plans to be approved with funds only released when certain work has been completed.
5. Utilise credit cards
Depending on your credit rating and income, you may be eligible for a credit card with a 0% interest offer on purchases. If you make the minimum repayment on time each month and clear the entire debt before the end of the 0% interest period, this type of credit card allows you to borrow money for free.
However, standard credit cards are much more expensive, with typical APRs from 18% upwards. Debts can quickly spiral if you miss payments.
Overdrafts are much more expensive – typically 40% APR – so should be avoided for long-term borrowing.
6. Bridging loans for short-term lending only
Bridging loans are short term loans which can usually be arranged very quickly — but they’re expensive.
You will need an ‘exit strategy’ before you’ll be approved for a bridging loan — this will normally be selling the property or refinancing.
Bridging loans are secured against your property so it’s at risk if something goes wrong. You’re also working towards a completion date so any delays in the project could mean further costs.
What is the best way to finance a home extension project?
It’s important to shop around and compare the different types of finance on offer. A good credit record is important for many types of finance so check your credit file doesn’t contain any inaccurate information.
If you have cash savings, the obvious benefit of taking this option is that you won’t need to borrow any money to fund your kitchen extension or other such extension project.
“If you’re planning significant work, it’s always worth saving whatever you can afford, as soon as you can afford to do so. It’s incredibly difficult to build tens of thousands of pounds for a big project, but once you get into doing the work, every penny you’ve saved is one you won’t have to borrow later,” says Sarah Coles, personal finance expert at Hargreaves Lansdown.
“However, it depends how much money you have saved up. It’s always best to have about six months’ worth of living expenses as cash savings for emergencies,” Cole advises.
If you borrow money to fund an extension, the important thing is to make sure you can afford the repayments on your remortgage, loan, credit card or other form of finance.
Gary Boakes, director at Verve Financial, says: “The most dangerous option is funding the property with loans and credit cards hoping that the home improvements will increase the property value to be able to remortgage at a later stage. With property prices expected to decrease you may be in a position where you don't have the equity to cover the loans and credit cards.”
Aaron Strutt, product and communications director at Trinity Financial, warns that debt consolidation remortgages are not as easy to get as they used to be.
“I spoke to someone recently who borrowed on cards to refurbish their property and now with the increase in interest rates they can't refinance,” he explains. “For many, it makes sense to remortgage and take the additional borrowing in one lump sum, rather than owing money to multiple firms.”
For your own peace of mind, as well as lenders’ checks, it’s crucial to be sure you can afford to repay any money you borrow for an extension project.
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