Financing a granny flat

[swanqueen]

Hi all,

I intend to build a granny flat on one of my IPs (lets call it IP1). As I understand it, there are 2 ways to finance a GF build - either use the existing equity in IP1, or obtain a construction loan for IP1.

My problem is that the projected value growth for IP1 in the next 2-3 years is likely to be slow, and I don't think I'll have enough equity in IP1 to finance the entire build. However I have enough equity in my other IP (let's call it IP2) to finance the GF build (I'm going by a rough cost of about 100k for a full turnkey build).

So my options are:

1. Obtain a construction loan for IP1
At the moment the LVR for IP1 sits at 81%. In a couple of years time it'll most likely hover around the 75% level. Assuming I can finance the 10% deposit myself, is this a viable way to proceed with obtaining finance? I also heard that valuation post-build is likely to value the GF at 70%... based on my calcs the final LVR post-build for IP1 + GF will be about 85%. Does that mean I'll be up for LMI? What other costs might I be up for?

2. Use equity in IP2 to finance the IP1 GF build
LVR for IP2 sits at 65%, and I have enough equity (circa 100k) to finance the GF in IP1. Drawing out the entire 100k would bring the IP2's LVR to about 80%, so no LMI involved. Would lenders allow me to use equity out of an IP to finance a build in a different IP? What about taxation, would this be allowed and classed as an investment expense (rather than a private expense)?

Which is my better option?

Can anyone help me with validating my thoughts above? Please feel free to pick holes in them

Thanks,
SQ

 

[Terry_w]

Why not go for 2.

Separate split, once it is finished you can increase the loan against the property with the granny flat and refinance the second split on the IP. This way you can get the property associated with the loan securing all the loans for that property

 

[neK]

why not both?

Get a construction loan up to whatever amount you can. Then get an Line of Credit.

The shortfall in the construction loan will need to be funded from the Line of Credit, once that bit is funded, you can use the construction loan.

During this process, do not use that Line of Credit for any other purpose other than funding the Granny Flat (eg build, concrete driveway, fence etc).

Once the build is complete, you can try for an equity release on IP1, you might get lucky a get the whole amount, otherwise you might get partial, or worse case you get no further equity release.

There will be some loan cleaning up to do, but a good broker will be able to sort this out for you.

Edit: Just read what TerryW wrote, essentially suggesting the same thing, except getting a construction loan.

 

[swanqueen]

Not sure I follow Terry and neK. I'll outline the steps I think you're suggesting, please correct me if I get it wrong.

Step 1 - I get the bank to release equity for IP2. Use this amount to finance GF construction for IP1.

Step 2 - Post construction, get bank to revalue IP1 along with the GF. The 'topped up' amount should be placed in a separate split.

Step 3 - Use the topped up amount from IP1 to pay back IP2's loan.

Is this right?

How does this 'loan cleaning up' work? It looks like we're just repaying one loan with another - I can understand why we'd want to do this in order to keep the loans separate, but wouldn't this muddy the loan purposes a little?

 

[neK]

By cleaning up, i simply mean that each loan is under the related property.

What you have outlined appears to be correct.

Might be easier i use some numbers.

IP1 Value = $500,000. 81% LVR = 405,000 Loan
IP2 Value = $666,000. 65% LVR = $429,000 Loan. Bring the loan up to 80% LVR means you can access a further $99,000

Option #1
Go to the lender and obtain a Line of Credit for $99,000 against IP2.
Use these funds to build granny flat.
Upon completion of granny flat, have IP1 revalued and see what equity can be extracted.

For example, if post granny flat, the valuation for IP1 comes up as $600,000, then at 80% LVR you can borrow a maximum of $480,000. So apply for a new loan account number of $75,000 ($480,000-$405,000).

Use $75,000 to repay existing line of credit against IP2 (however there would still be $24,000 still owing). As such, you would need to split the $99,000 LOC into $24,000 and $75,000. This way the $24,000 remains untainted and you can do what you want with the $75,000, whether it be buy another property etc. (This is what I refer to as "cleaning up").

Another situation would be if post granny flat, the valuation for IP1 comes up at $700,000, borrowing 80%, would allow you to obtain $560,000. Given an existing loan of $405,000, this would allow you to access $155,000.

Knowing the Line of Credit from IP2 is $99,000, you would split the $155,000 as $99,000 and $56,000. Thus moving the debt from IP2 back to IP1 ("cleaning up" so to speak).


Option #2 = Line of Credit + Construction Loan.
Go to the lender and obtain a Line of Credit for $99,000 against IP2.
Go to the lender and obtain a Construction loan to build the granny flat. The likelihood of them giving you enough funds to cover this is low. They may only give you 70k. You would then use the LOC against IP2 to fund the difference.

Upon completion of the granny flat, you would get it revalued to see if the value has increased enough so you can get a further $30k out of IP1 to repaying the LOC against IP2.

Benefits of using Option #2 - if you only got $100k Line of Credit, you are limited to $100k build including any fencing / landscaping etc. By using a construction loan and Line of Credit, your budget is bigger

 

[Peter_Tersteeg]

If you've got a fixed price building contract with a registered builder, you can use a construction loan. The equity in the existing property will also come into play about how the figures wash out.

If you're building something yourself or it's a smallish amount, set up an equity loan prior to building and fund it on that basis.

The real answer to the question is that it depends on how the granny flat is being built.

 

[swanqueen]

Thanks all, this has given me some food for thought.

 

[Sydniygirl]

At the risk of sounding stupid, there is no talk about serviceability here. Isn't the assumption that not only do you need equity or a deposit, you also need enough income other than the income from the granny flat, to get a loan. Is there anyway a pensioner for example, with equity in their home could get a loan solely based on the income from the rent covering the repayments? I don't think this is possible.

 

[neK]

They asked about loan structure, hence the answer was based on that.

Regarding serviceability, of course that's an issue, but one they would have to deal with - a good broker helps of course.

Its like some one asking if they think a particular property is good value, however instead of answering the question one responds about their serviceability and that they may not get the loan therefore they shouldn't bother asking any other question until they state in their initial post that serviceability is not an issue.