Renovation – financing at low interest rates

By Jürg Zulliger

Owning your own home has never been as important as it is today. However, a nice home environment also means that now many owners are in the mood for renovation. Perhaps the carpets or kitchen furniture are reminders of times gone by. In many cases, people want to improve the room layout or may even need more living space; for instance, if they work from home or the children are getting older.

Renovation – now is the time

If you have your bank financing already sorted out, you are in a good position. Mortgage interest rates are extremely low, and many banks consider property owners to be attractive customers. Although there is no clear lower limit for a bank loan, as a rule of thumb, banking experts advise that ongoing maintenance should be financed through the household budget. If you want to fix a broken washing machine or have two bedrooms painted, you generally must pay for this from your own pocket.

If you are thinking of a larger sum, however, you may be well advised to consider a renovation loan. But how do you go about getting your project and its financing off the ground? As a basic rule, if, for instance, you want to take out an additional CHF 100,000 or CHF 200,000 on top of your existing mortgage, the usual property financing standards apply. There are two ‘golden rules’:

• Loan-to-value ratio: the maximum loan-to-value ratio is 80%. The new mortgage total may not exceed this threshold (after renovation).
• Affordability: for renovations, the affordability rule must be kept in mind, similar to the initial financing. The bank calculates the total loan amount and the resulting annual cost (interest, repayments, incidental costs). These fixed costs may not exceed one third of your gross income. The banks calculate affordability very conservatively, using a longer-term average interest rate of 4.5% or 5%.

If you are not familiar with the practical aspects of financing renovations, you may think that the hurdles are high. However, today the opposite is the case and many households and families have an excellent chance of having their renovation plans approved by a bank.

Financing your renovation – check the loan-to-value ratio

Why? Let's look at a real-life example. Ten years ago, a homeowner paid CHF 1 million for their dream apartment. Since then, they have repaid 1% of the mortgage every year. At the same time, the property’s market value has gone up since the purchase.

Says Florian Schubiger, finance expert at VermögensPartner in Zurich: ‘After 10 years of ownership, the vast majority of home owners today will have some leeway.’ This means that the loan-to-value ratio will be down to 50% or 60%. The conditions for making renovation dreams come true are thus rather good. Obtaining an additional CHF 100,000 or CHF 200,000 for home investment should be feasible. However, the bank will generally also have an eye on the second fundamental element, namely the client's income and the financial sustainability of the loan.

Increase in value?

With renovations, there is always the question as to what extent an amount of, for example, CHF 100,000 should be counted as an increase in value. If the bank takes a cautious approach and argues that the project is a case of straightforward building maintenance, it may be difficult to obtain a loan.

According to Schubiger, different viewpoints come into play in practice: ‘Some banks use certain empirical values and estimate that about 50% to 70% of a renovation can be effectively counted as an increase in value.’ Hence, the total investment sum only partially increases the property's value. The leeway in terms of the loan-to-value ratio may be a little lower than the customer thought. A second example is that the bank estimates the property value before and after the renovation. Today, most banks have their own tools and market data on which to base their estimate. A clear picture soon emerges and the bank will specifically quantify the extent to which projects, such as a conservatory or converted attic, will increase the estimated value.

We recommend: There is always a certain amount of leeway when it comes to renovation financing. It is often worthwhile obtaining a comparison quote from another bank or insurance company. Aside from banks, potential sources of funds also include pension fund or 3rd pillar assets (provided the renovation raises the property value). We recommend that you contact your employee benefits institution.

Age 55 and above – plan your finances carefully

Every now and then, stories crop up in the media about retirees who have difficulty in getting their mortgages increased. Lending requirements have definitely become stricter. Today, banks pay closer attention to the ‘golden rules’ mentioned above. Anyone aged over 55 should keep this in mind when planning their finances.

The fact that nowadays retirement pensions are often a lot lower than the previous earned income affects the borrowing capacity and affordability in this age group.

We recommend: If you are planning to convert or renovate your home at this age, be particularly diligent when planning your finances. Perhaps for a variety of reasons it may be better to put off your dream of renovation. A good approach is to check your finances and make a pre and post-retirement budget.

Renovation financing – concrete process

In the past, banks typically financed construction and renovation projects of all kinds via building loans. All payments are then made via the bank; i.e. payments are paid directly from the relevant building loan account at the bank. However, this service comes at a price. The quarterly interest is substantially higher than the otherwise very low mortgage interest level.

Says Schubiger: ‘The specific details depend largely on the loan amount and to a certain extent on the negotiations with the bank.’ For instance, a home owner has promptly amortised their mortgage and everything is right on track. They then apply for a loan of CHF 50,000 for new windows and energy efficiency improvements.

In this clear-cut case, it would probably be simpler and cheaper to top up the mortgage. Generally, it would be enough to explain the project and send the cost estimate to the bank. If the loan-to-value ratio leaves less room for manoeuvre and it is a larger project, many banks will still lean towards a building loan or construction financing. In this case, more detailed documents, such as cost estimates, invoices, etc, must be submitted.

Convenient online top-up

If you have taken out a mortgage online, you can usually initiate the top-up process yourself. In the mortgage self-management section, select the corresponding ‘Top-up’ button and enter the relevant details (amount of the requested renovation loan, current income, etc.). Again, the same basic rule applies: the bank is obliged to check compliance with the ‘golden rules’. The decisive factors are the property’s current estimated market value and adherence to the loan-to-value limits and affordability requirements. If this is the case, it does not matter whether you want to convert the roof or build a swimming pool.

Increase in value through renovation

In summary, your chances are much better if you know the main rules of the game. Banks are usually accommodating and straightforward when it comes to maintaining or enhancing a property’s value, since they consider a property in good shape as a safe asset.