In Australia we’re spoiled for choice when it comes to home renovation inspiration. From TV shows to social media, and from weekend newspaper supplements to taking a walk around your neighbourhood – many Aussies nationwide have caught the reno bug.

But no matter how well considered or high quality a renovation, there’s a risk that homeowners and investors alike can overcapitalise on a home. And that can lead to financial stress and heartbreak.

So, today we’re looking at overcapitalising and how to avoid it.

How to avoid overcapitalising on your home loan

When improvements are made to a property, it generally increases in value. It follows that renovating your home is considered an improvement to your property. But there are situations where you may have spent too much money on your renovations – this is known as overcapitalisation.

What is home loan overcapitalisation?

In a nutshell, to overcapitalise on your home loan, there must be three components:

• You have a property which you purchased with a home loan.
• You have spent money on improving that property, for example through renovation.
• The property’s market value is now less than what you paid for the property plus what you spent on improving it.

If you plan on living in your home for a long time, perhaps it doesn’t matter that you spent more on improvements than what it’s currently worth. However, if you find yourself in a position where you need to sell an overcapitalised property, it means you won’t earn back the money you’ve spent on it.

How to avoid overcapitalising your home loan?

Know your home’s value

When improvements are made to a property, it generally increases in value. But how do you determine that value?

First, it’s a good idea to look at the comparative value. This is generally the range of sale prices for comparable homes in your suburb.

If you paid $500,000 for your home and plan a $200,000 renovation, this will make your home a $700,000 home. But if houses in your suburb commonly sell for $350,000 to $550,000, it might not make good financial sense to renovate your home to such a high price point.

Second, you need to know your home’s current market value. If it’s been a while since you purchased your home, it may be an idea to get a home valuation prior to renovating. Or perhaps you can speak to a local real estate agent about comparable unrenovated and renovated homes in your area. This can help guide your renovation choices and budget.

Be renovation savvy

Be clear on why you are renovating and what you want from it. Do you want a quick return on your investment? Or do you want a comfortable home you’ll enjoy living in? This choice will drive your renovation budget and needs.

You should also be familiar with what other homeowners in your area are doing to their properties. Peek through open homes and ask local real estate agents about the buyer-feedback they’re getting for homes in your area.

Plan the renovation of your dreams but stay savvy. Any ‘specific personal interest’ renovation decisions tend to be of high emotional value to you, but perhaps not to potential buyers down the track. By this we mean elements such as:

• Renovations with significant ongoing maintenance costs. These could be in-ground pools, tennis courts or wireless home entertainment systems that require ongoing technology updates. While these might be wonderful at the time, you’re limiting your potential buying pool to those also willing to pay for and maintain a pool, court or high-tech equipment.
• Bespoke or trendy interior design aesthetics. Embossed wallpaper hand-designed by an Italian artisan sounds glorious – but you can’t take it with you at sale time. And you’d most likely need to remove it or paint over it (at further cost). Incorporate your personal aesthetic in your home through decorative furnishings and soft furnishing elements, rather than as part of your renovation budget.

Stick to your budget

Research all the associated costs of your planned renovation and write up a budget. Then stick to it as closely as you possibly can. Include wriggle room for surprises (such as existing damage to your foundations or pipes that need replacing) and delays.

Having a sensible, clear budget to guide you can be very helpful when making potentially emotion-driven choices for fittings and fixtures in your home.

Be realistic

You may plan on renovating and living in your home for the next 20 years and wish to customise and modify your home to suit a growing family’s needs. This can give you a little breathing space for a more personally-driven renovation, as overcapitalisation is unlikely to be an issue – assuming an increase in long-term property values.

But always be mindful of your budget and comparable sales prices to avoid overcapitalising. You don’t want to be the only home with a third bathroom, walk-in butler’s pantry, hand-crafted tile pathways and a sunken spa. This may all be your dream – but you don’t know what the future holds, and may need to sell your home earlier than anticipated.

Get expert advice

If your home is older and you are unsure if something is lurking unseen within the walls, roof, foundations or underground, consider getting a pre-renovation report from a licensed builder. Going fully eyes-open into a renovation will help you to identify and address any potentially problematic areas and plan your budget accordingly.

If you have overcapitalised

If you have overcapitalised, it may be worth waiting to sell until market conditions improve. If you cannot wait for this to happen and are struggling with your repayments, get in touch with us. There are other options, such as refinancing.

If you are worried about overcapitalising, talk to us. Our expert term can do a free personal home loan assessment and talk through refinancing options too.