Renovating Your Home: Should You Take A Renovation Loan Or Personal Loan?

Home renovations are expensive, making them a major financial undertaking, especially for young homeowners who’ve just bought their first home. It is not uncommon for homeowners to take out a loan to help pay the bill, which easily costs tens of thousands of dollars.

Both renovation loans and personal loans are viable options for home renovations, but there are differences in how they work.

Let’s examine how personal loans and renovation loans work together when embarking on a home improvement project.

Home renovations are expensive, making them a major financial undertaking, especially for young homeowners who’ve just bought their first home. It is not uncommon for homeowners to take out a loan to help pay the bill, which easily costs tens of thousands of dollars.

Both renovation loans and personal loans are viable options for home renovations, but there are differences in how they work.

Let’s examine how personal loans and renovation loans work together when embarking on a home improvement project.

At-a-glance: Renovation loan vs personal loan

Understanding renovation loans

Renovation loans are a type of unsecured loan that is catered to the needs of homeowners looking to embark on a home improvement or renovation project. 

While there is no collateral required, renovation loans are comparatively more cost-effective than other types of unsecured loans. 

However, renovation loans can only be used to pay for approved renovation works, and determined and verified by the lender.

What is required when applying for a renovation loan?

Renovation loans cannot be approved without an official quotation. 

You will first need to approach a contractor or interior design firm for a discussion on the renovation works you require. 

Thereafter you should obtain an official quotation for the renovation project, which you will then submit along with your loan application. 

After your loan has been approved, you will not be receiving the funds into your account. Instead, the bank will prepare cashier’s orders on your behalf, which are then passed to the contractor or ID firm as payment. 

Typically, up to four cashier’s orders are provided, allowing you to pay your contractor in stages, instead of all at one go. You may request for additional cashier’s orders if you want to split your payments up further.

Cashier’s orders will be chargeable, although some banks may offer you a certain number for free. 

How much can you borrow through a renovation loan?

You may borrow up to six times your monthly salary, capped at a maximum of S$30,000. This S$30,000 limit applies even if you are making a joint application. 

Note that joint applications may only be allowed with a parent, sibling, child or spouse. In a joint application, you may borrow up to 2 x 6 times the lower monthly salary of the two applications, but the overall cap of S$30,000 still remains.

Eligibility requirements for renovation loans include age (at least 21), property ownership or consent from the owner, and annual income – this varies between banks, sometimes widely. 

Citizens, PRs and foreigners residing in Singapore are eligible to apply for renovation loans, but some requirements may vary.

Renovation loan or personal loan: Key considerations

Here are the two key considerations when deciding between a renovation loan and a personal loan for your home improvement project.

Renovation loans come with lower cost of borrowing

While the advertised interest rate on a renovation loan may be larger than that of a personal loan, that may not be representative of the truth. Renovation loans typically have a lower Effective Interest Rate (EIR) compared to personal loans, due to the different calculation methods used. 

You see, interest for renovation loans are calculated using the monthly rest method, where the interest is charged on the amount that is still outstanding on the loan. This results in overall less interest paid, which translates to a lower EIR.

On the other hand, personal loan interest charges are derived using the flat rate method. This means that interest is calculated on the loan principal, leading to a higher EIR. 

Given this difference, it is more cost-effective to park a larger portion of your budget under the renovation loan, instead of vice versa. 

Personal loans offer potentially larger loan amounts

Personal loans can potentially generate a higher loan amount even if the average customer can only borrow up to 4x monthly salary. This is because renovation loans are capped at S$30,000, and this limit stands even if a joint application is made by two borrowers. 

The limits on personal loans are applied on a per-individual basis, which opens up the way for you and your spouse to effectively double your renovation budget by taking out separate personal loans.

Of course, this must be done prudently and according to each borrower’s financial ability to repay the loan.

The bottom line

When you’re embarking on home renovations, your default choice should be a renovation loan, as you will be able to access lower EIR and thus reduce your cost of borrowing. 

However, given that renovation loans are capped at S$30,000, you will have to be prudent about the works that you spend your renovation loan on. 

As a rule, prioritise renovation essentials (such as plumbing works, carpentry or electrical wiring), and use your savings or a personal loan to cover good-to-haves (such as ceiling cornices or stained glass inlays for your bathroom mirror). 

What about furniture and appliances? Well, that will have to be budgeted for separately, given the low ceiling on renovation loans. 

Also, banks can be pretty adamant about you only using your renovation loan to pay for actual renovation work. 

Your bank may conduct a site visit to ensure that the loan is being used for approved renovation works only – i.e., renovation works which are permanent in nature. Items that do not fall under the list of approved works and installations will not be allowed to be deducted from the renovation loan granted. 

This essentially reduces the size of your renovation loan, which means you will have to pay for those expenses through your savings or other methods. If you do not have the funds available to cover the additional expenses, you may find yourself in an unexpected financial pickle.

Admittedly, the chances of this happening is quite rare, judging by the lack of online chatter about this exact scenario. But in any case, it’s still good to be aware of the possibility of such a situation arising, and plan accordingly.