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It’s best to wait until the construction work is done before calling one the appraiser. ‘You want to have it livable,’ one mortgage broker says. ‘You can’t have a construction site.’

The Globe and Mail

The tastes of financial lenders: They're the last thing on the mind of home renovators, but they should maybe be the first.

No, banks and other lenders don't care about homey aesthetics, paint colours or kitchen fixtures. Their taste squarely revolves around whether a house that needs refinancing for a renovation is more or less livable, and not a construction site. Mortgage brokers explain that ignoring this preference among lenders can make reno financing more difficult.

Small renos can easily be paid for through a home equity line of credit, for instance, which tends to keep lenders at bay. But when home renos involve, say, breaking an existing mortgage and refinancing to an amount closer to the new, higher, postrenovation value of the house, things can get much more complicated.

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Firstly, the house may have to get reappraised, a potential pitfall if not done correctly.

Iain Macfadyen at YourVancouverMortgageBroker.ca described how a client in New Westminster, B.C., managed to avoid this problem. The client was gutting the family home. Being in the construction industry himself, the client was very hands-on in the reno process.

The trick, Mr. Macfadyen said, was that when the house needed to be appraised to proceed with refinancing, the client made sure the house was still functioning as a home. This helped to keep the appraised value high.

"In the downstairs, he had already taken out a wall and put up drywall, put in new floors," Mr. Macfadyen said. "Basically, the plan was to do the downstairs, and then do a whole reno on the upstairs." A new room was prepared for where a new kitchen would be.

But Mr. Macfadyen advised the client to wait until after the appraisal before ripping out the old, working kitchen. "If they don't see one there, it's not going to turn out well," Mr. Macfadyen said. "The appraiser wants to see a livable property. They don't care about the process of the renovation. ...You want to have it livable. You can't have a construction site."

The reason is that "institutions don't want to lend on incomplete houses," he added. "Even if it's going to be much nicer, it's basically a glass half empty. And they [the mortgage lenders] are going to assume the renovation won't be done, and they don't want to be stuck foreclosing on a place that's not complete." A positive appraisal helps ensure his client had enough money to complete the repairs.

Another pitfall is underbudgeting a reno. As everyone knows who has been through one, home renovations almost always cost more than expected. Who knows what contractors will find inside that old wall?

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"That's one of the biggest pitfalls I see with people doing renos. They don't budget for overruns, they don't have enough money and they're stuck with an incomplete property," Mr. Macfadyen said.

While overestimating just means paying back the extra money borrowed, underestimating can mean having to start the whole refinancing process again, likely incurring heavy penalties.

"They [the lenders and appraiser] are going to want to see the property again. More transaction fees. Possibly breaking your old mortgage. There are so many more potential costs if you get it wrong, compared to taking too much money out," Mr. Macfadyen said.

Part of the problem with budgeting a reno can be not accurately gauging what the value of the home will be after renovations. A common problem is overestimating how much the reno will raise the property's value.

"Sometimes [people] get over their head because they don't have an end value in sight when they start their project," said Halifax mortgage broker Pat Sawler at Craigburn Capital. "Say their house was worth $250,000 now, and they put $50,000 into it. They think it's going to be worth $300,000, but it only adds $15,000 to the value of the property."

That can be a problem if the homeowners can't borrow as much as they had hoped, because the appraised value is lower than anticipated. "That's when people get over their heads," he said.

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There really isn't a preferred way to finance a reno, say brokers. It all comes down to the individual house and its homeowners.

"Once I understand what the clients are trying to do, the value of their home, the amount of renovation money they need, the details of their existing mortgage (the penalty to break, what the rate is, whether the lender is allowed a second charge), then I can help them determine what the cheapest/easiest route is for them to achieve their goal," said Vancouver mortgage broker Patricia Collins in an e-mail.

Many brokers advise leaving the option open of possibly rolling the line-of-credit debt into the larger mortgage when that mortgage comes up for renewal. That can effect the timing of the reno. In fact, timing, like when to have the home appraised, can be key.

Yet, homeowners always need to heed the preferences of the lenders. They want to see the costs upfront, and they want to make sure the renos will indeed be completed. This is particularly important when financing the mortgage and renovation costs at the same time (with either a purchase and improvement mortgage, or with a refinancing and improvement mortgage).

"The improvement money is held back by either the lawyer or lender until the work is complete, and is only released once the work has been confirmed complete. Some lenders take paid receipts, some require an appraiser to inspect and confirm," said Ms. Collins.

"This is the only way the lender can guarantee the money is truly going toward [the reno] and is secured against the home, rather than to a new boat," she said.

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"It's good for the buyer because it forces them to actually get the work done quickly."

Editor's note: The company is YourVancouverMortgageBroker.ca, not .com, as was written in a previous version. This is the corrected version of the piece.

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