Q&A: Looking for options for renovation nest egg

My wife and I recently sold our family home. We are close to buying an old house that we would like to renovate and extend over the next few years. Luckily, we have some positive equity from the sale of our home. Under the Central Bank mortgage rules, a certain portion of this will have to be used to cover the 20 per cent deposit required for the purchase of our new home (circa €150,000). We expect to have about €125,000 left after this 20 per cent deposit is paid.

Would you recommend keeping this excess in some form of interest-bearing deposit account until we do the renovation works in the next one to three years? Or, are we best to put most of the excess into the purchase price of the home? This second option might then put us in a better position to refinance our existing mortgage when we are ready to do the renovation in the next few years, as we would have more equity in the new house (assuming of course prices remain relatively stable). We understand the work will cost more than €200,000 and so we will need some bank finance to fund it. — Mr KS, email

You have clearly thought this plan through but perhaps you’re overthinking it. The good news is that you have already sold your home so there is no chain to worry about as you close in on the property you want to purchase. And, even better, although you both have things you wish to do to upgrade the property to make it the home you want it to be, you at least have some of the resources to make that happen.

You’re quite correct that your lender will expect you to put up 20 per cent of the price of the new home. That is the standard deposit for those moving homes under Central Bank rules. There is the possibility of an exception being made to these rules but they’re reluctant enough to give it and, if you don’t need it, it’s probably best not to push for it.

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That might seem strange. After all, securing an exception so that you only require a 10 per cent deposit would allow you to save more of the equity from the sale of your current home, as you would be borrowing 90 per cent of the purchase price at mortgage rates that will be lower than any other loan you take. But you are still going to have to borrow something. As it stands, you think you will need €200,000 for all the renovations you envisage. Renovation budgets are exceeded as a matter of course. I don’t think I have ever come across one that came in at or under the original budget. Given the squeeze on supply in the construction sector and the current rate of inflation on both labour and materials, it seems inevitable that you will end up needing €20,000-€40,000 more than you imagine.

You expect to have €125,000 in savings from your current home sale after you pay a 20 per cent deposit. Getting the deposit down to 10-15 per cent would boost the savings to €160,000-€200,000. There is no wriggle room there, even if everything fell into place. You will inevitably have to borrow for the renovation and the impression given by pursuing a deposit exemption might make the bank more wary about further lending.

But what about your proposal not to hold on to the €125,000 surplus but to put it into the property, meaning you are taking a lower mortgage — just under 65 per cent rather than 80 per cent — and possibly even at a more preferential rate? So far, so good.

Or maybe not. For one, you may well be forced to look at a variable interest rate if you are not sure when you will need to access funds for the renovation, especially as your timeline is one to three years. While you could currently borrow at a four-year fixed rate of about 2.05 per cent, meaning a monthly payment of about €1,763 on a €475,000 mortgage loan, you would pay closer to 2.7 per cent for a variable rate — or €2,505 a month. That’s €742 more every month, or close to €9,000 difference in just one year in repayments.

And when you have a better idea of where you are financially and approach the banks for the balance of the cash you need, the interest rate will almost inevitably be higher. The European Central Bank is signalling an increase of between half and three-quarters of a percentage point in interest rates this year alone — and it could yet be more. All the advice right now is to lock in your mortgage at what are historically low long-term fixed rates. By deciding otherwise, it seems certain that you will face a bigger financial burden both in terms of monthly payments and the overall cost of credit over the life of the mortgage.

Your best bet is probably to lock in your 80 per cent mortgage at the best long-term rate you can; put the €125,000 surplus into an easy access account and see what is the best rate at which you can borrow any extra required when the bills for the renovation arrive.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street Dublin 2, or by email to dominic.coyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice