Q.After much thought, my wife and I have decided to stay in the house we have lived in for the last eight years. We realize that we could probably pounce on a good deal right now. On the other hand, we realize that we probably cannot get top dollar for our house if we tried to sell it today.
Our house is too small now that we have two children. Since we plan on staying in this house for eight or 10 more years, we want to build an addition that will add a master bedroom, family room and larger kitchen. We plan on refinancing and getting up to $150,000 to pay for it. Our house is worth about $400,000 now, and we have a 30-year fixed-rate loan at 4.875 percent with a balance of about $100,000.
We have several questions. Should we consider a home equity line of credit? The rates are really low, and I would hate to refinance to a rate that’s higher than our existing rate. Also, I have heard that homeowners who remodel their homes don’t get their money out dollar for dollar when they sell. I don’t want to spend $150,000 on our house if it will only add $100,000 to the value.
Thanks for your time.
A. I have a lot of personal experience with home additions and renovations and am, therefore, not without an opinion.
The rates are currently very low on home equity lines of credit (HELOCs) because they are tied to the prime rate, which is currently at 3.25 percent. Since you may spend as much as $150,000 on the project, this would mean your total mortgage debt would total about $250,000 when everything is complete. If you took out a HELOC for the entire amount, 60 percent of your total mortgage debt would be subject to rate changes. Since you are planning on staying in the home for eight or 10 more years, I think you would be subjecting yourself to an unacceptable level of interest-rate risk.
I would suggest that you refinance your existing mortgage and take out the cash necessary to complete the project. Even if you refinance to a rate of 5 percent, essentially giving up your 4.875 percent rate, it’s only on $100,000 of the $250,000 you will need. If you take out a HELOC in the amount of $150,000 and the rate eventually jumps to 7 percent, the 4.875 percent rate on your first trust won’t provide a lot of solace.
If you are unsure about the actual cost of the project, you may want to consider refinancing and getting less cash out and having a line of credit set up in case you need extra cash to finish off the project. Under this scenario, there would only be a small portion of your mortgage debt subject to interest-rate changes.
Let’s talk about the criteria that determine whether or not a house project is ultimately profitable. I have clients who refinanced their mortgage and complained about the appraisal because they didn’t believe the appraiser gave enough value to certain improvements that were made. Specifically, I remember speaking with a client several years ago who was upset that his appraisal report didn’t indicate a $10,000 increase in value as a result of the imported Italian tile he recently installed in his foyer. I had to explain to him that his project constituted an “overimprovement” for the house and neighborhood. Most potential buyers of his house would not pay an extra $10,000 just because the foyer is tiled with some fancy tile.
On the other hand, additions that are efficiently constructed and practical can be very profitable. Increasing heated and cooled square footage to add a bedroom and family room is very practical. I think you’re on the right track.
Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at henrysavage@pmcmortgage.com.
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