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When it comes to return on investment (ROI), not all home improvements are equal. The right ones can improve your home’s comfort, looks or security, add value, and make it easier to sell. The wrong ones do the opposite.
- The best home improvement projects vary by location — pools rule in Arizona, but not in Montana
- Many of the highest-returning investments are also the smallest — for example, new paint
- If a room is particularly dated or non-functional, a renovation will deliver more value
Note that what you pay to finance your improvements directly affects your costs and your ROI.
ROI for home improvements is falling
If you’re an HGTV fan , you know that certain remodeling projects can boost your home’s resale value. What you may not know is that it’s becoming harder to recoup the money you put into renovations.
Spending $50,000 to build a backyard patio doesn’t mean you’ll get an extra $50,000 when you sell the house.
In fact, according to Remodeling magazine’s 2018 Cost vs. Value Report, the average ROI for a new patio is just 47.60 percent.
Five or 10 years ago, renovating the kitchen and bathrooms might have produced an ROI of 100 percent or more. Not today. Thanks to rising real estate and construction prices, projects that once paid for themselves no longer add as much value.
The Remodeling report found that, overall, homeowners will earn back only 56 percent of their renovation investments. During the previous two years, the average was 64 percent.
However, home improvements can help you sell your home faster. If you have a mortgage, selling in 30 days versus 120 can save you thousands. And before selling, you get a nicer, more comfortable,efficient and / or secure house.
Many home improvement projects with the best ROI are the least expensive. And other projects like power washing, deep cleaning, and adding a few plants near the entry can deliver great results when you sell— easily recouping your investment and then some.
Best and worst home remodeling projects
In terms of ROI, the 5 best remodeling projects for 2018 are:
- Garage door replacement. Cost: $3,470. Cost Recouped: 98.30 percent
- Manufactured stone veneer. Cost: $8,221. Cost Recouped: 97.10 percent
- Deck addition (wood). Cost: $10,950. Cost Recouped: 82.80 percent
- Minor kitchen remodel. Cost: $21,198. Cost Recouped: 81.10 percent
- Siding replacement. Cost: $15,072. Cost Recouped: 76.70 percent
The 5 worst projects are:
- Backyard patio. Cost: $54,130. Cost Recouped: 47.60 percent
- Master suite addition. Cost: $256,229. Cost Recouped: 48.30 percent
- Major kitchen remodel (upscale). Cost: $125,721. Cost Recouped: 53.50 percent
- Bathroom addition (mid-range). Cost: $83,869. Cost Recouped: 54.60 percent
- Bathroom remodel. Cost: $61,662. Cost Recouped: 56.20 percent
Keep in mind that these are national averages. Your ROI may differ depending on the home’s condition prior to improvement, and your location.
For example, adding a swimming pool to your Florida property is probably a wise investment. But in Minnesota? Not so much.
If your kitchen is really dated and ugly, a mid-level remodel will likely more than pay for itself. People hate ugly kitchens and bathrooms.
Concentrate on ‘curb appeal’
If your front lawn looks like a set from American Horror Story, it won’t matter how much you spent on granite countertops in the kitchen. Most buyers will drive past without bothering to look inside the house.
For a few hundred dollars, you could remedy that problem.
Touch up the paint on the front door, powerwash the home’s siding and walkways, or plant new shrubs and flowers. These improvements will convince more buyers to step out of their cars and into your house. Then you can showcase your big-ticket renovations.
Another rule of thumb: renovating a dated or non-functional room delivers more value than remodeling a room to better suit your tastes.
BTW: if your tastes are somewhat “unique,” a remodeling project could actually decrease your home’s value.
How to finance home improvements
Once you decide what to remodel, it’s time to decide how you’ll pay for the work. In general, the loans with higher fees — cash-out refinancing and home equity loans — are best for large projects requiring a lump sum upfront, such as paying a builder for a home addition. These loans have lower interest rates than the other choices.
Other loans have lower fees but higher interest rates. They include HELOCs, personal loans and credit cards. They can be better when you don’t need the money for too long, or you’re undertaking smaller projects, or when you will be renovating in stages and don’t know the exact costs.
Cash-out mortgage refinance
This is the most common way to finance home renovations. With a cash-out refinance, you refinance the existing mortgage for more than the outstanding balance. You then keep the difference between the new and old loans.
If you have a lot of equity in your home, a cash-out refi lets you free up a sizable sum for renovations. However, if you don’t have enough equity or your credit score is lackluster, you may find it difficult (or impossible) to qualify for a loan in the amount you need.
Note that cash-out refinancing is a more expensive option. There are risk-based pricing adjustments that apply to the entire mortgage, not just the cash out. It’s not your best choice if you only need a relatively small amount.
If you refinance a $200,000 mortgage to get $20,000, the title charges and lender fees could easily top 20 percent of your cash out. Even credit card interest is probably lower than 20 percent.
Home equity loans and HELOCs
These loans are both mortgages, secured by your home. if you fail to repay them as agreed, you can end up in foreclosure. But because they are secured by your home, they do offer lower interest rates.
Home equity loan
A home equity loan is a (usually) fixed-rate mortgage. In most cases, you can borrow up to 80 percent (90 percent if you are a perfect borrower) of your home’s market value minus what you still owe on the mortgage.
It is sometimes called a second mortgage, because in a foreclosure, the lender with the first mortgage gets paid first out of the foreclosure sale, and the second mortgage lender (aka the junior lender) gets repaid only if there is enough money.
On the plus side, home equity loans tend to be approved faster than cash-out refinances. They also have lower closing costs. On the minus side, your interest rate is higher, because they are riskier to lenders.
Home equity loans are great for projects that require a lump sum, when you have to pay a builder upfront, for instance. It’s better if you know your total costs in advance, because your loan amount is fixed.
Home equity lines of credit (HELOCs)
HELOCs are revolving credit lines that typically come with variable rates. That means they function like big credit cards — you can draw money, make payments, and draw more, up to your credit limit. Unlike credit cards, however, they do have predetermined terms, usually between 10 and 20 years.
HELOCs have two phases — drawing and repayment. During the draw period, you use the line of credit all you want, and your minimum payment may cover just the interest. But after a few years (this varies and depends on the loan’s term), the draw period ends and your loan enters the repayment phase. At this point, you can no longer draw funds.
HELOCs have low (even zero, in some cases) closing costs and low monthly payments during the draw period. But your monthly payments could soar once the repayment phase begins, especially if interest rates rise. The main disadvantage of HELOCs is that they are harder to budget for than fixed second mortgages.
The advantage of HELOCs is their flexibility. You only pay interest on the amount you use. They are great for projects that have many stages, or in cases when you don’t know the exact costs of your renovation.
Personal loans and lines of credit
These loans, also called “signature loans” are available mostly to applicants with excellent credit. Rates and fees vary widely, so it pays to shop.
Because you don’t put up collateral for an unsecured personal loan, you don’t risk losing your home in the event of a default. Otherwise, the chief advantages are the speed and simplicity of the application and approval processes.
The rates for personal loans are significantly higher than for cash-out refinances and home equity loans. And loan amounts are usually smaller.
Personal lines of credit
These are revolving lines of credit that let you borrow what you need, when you need it, up to the credit limit. Essentially, they function like credit cards, but without the plastic (unless they’re linked to a debit card).
Almost all credit lines have variable interest rates. And if the rate is raised, it can be applied to your existing balance – something credit card companies are not allowed to do.
As of June 2018, credit cards have an average APR of 17.01 percent. If you run up a large balance and don’t repay it quickly, they can be very expensive. But for short-term help, credit cards can be a great option.
You can even use rewards cards to get travel or cash back, then pay them off with a personal loan or zero-interest balance transfer card to lock in a better rate. These cards offer zero interest for up to 18 months. Note that there is a fee, usually three percent.
Fannie Mae HomeStyle®
Fannie Mae’s program may be the best home improvement loan for bigger projects. You may be able to finance 97 percent of your primary residence property value if Fannie Mae’s proprietary Desktop Underwriter (DU) software approves you.
Borrowers can finance renovations to multi-unit properties, guest houses and manufactured homes. For traditional houses, the program allows a renovation budget of up to 75 percent of the acquisition plus renovation costs or 75 percent of the “as completed” value, whichever is less.
FHA 203(k) Loans
A Federal Housing Administration (FHA) 203(k) loan allows you to simultaneously borrow money for both a home purchase and home improvements. So you can buy and renovate a home with one loan. The minimum down payment is just 3.5 percent.
If you already own your home, you can refinance with a 203(k). Even if you have little-to-no home equity. That’s because it’s the improved value that determines your maximum loan amount, not your current home value. You can borrow up to 96.5 percent of the improved property value.
Because 203(k) loans are guaranteed by the FHA, it’s easier to get approved, even with a lower credit score. But these relaxed financial standards are offset by strict guidelines for the property. The house must be a primary residence and renovations can’t include anything the FHA defines as a “luxury.”
Because of the paperwork involved, and the requirement that you use only licensed contractors, these loans are best suited for major-league rehabilitation work. In addition, you’ll pay FHA mortgage insurance premiums, and these don’t go away until you sell or refinance.
FHA Title 1 loans
These loans can be either mortgages (above $7,500) or personal loans ($7,500 or less). The FHA guarantees this financing for home renovations, repairs or alterations.
A Title 1 loan lets you borrow up to $25,000 for a single-family home, and up to $12,000 per living unit (maximum of five units) for multi family homes. You don’t need home equity, and even applicants with lower-than-average credit scores may qualify. However, Title 1 loans can be harder to find than other loans.
State and local financing
You may be able to choose from programs administered by state and local governments, and charitable organizations. Many of those have income-related eligibility requirements. They can help with financing a “fixer-upper” purchase, energy efficient improvements, adaptive changes for disabled homeowners, and other projects.
With a 401k loan, you can borrow as much as $50,000 or half the value of your savings. In addition, repayments of interest and principle go back into your account. In other words, you repay yourself.
However, these loans come with significant risk. First, you can’t contribute to your account while you owe a balance against it. That could really impact your retirement if repayment takes a long time.
If you leave your employer (or get laid off) and don’t repay the loan within 30-to-60 days, the balance becomes taxable and you’ll also be slapped with a 10 percent fine. You won’t get penalized if you’re at least 55 years old.
If you don’t repay the loan before you turn 59 1/2, any outstanding balance will be considered taxable income to you, but you won’t have the 10 percent penalty.
Don’t borrow from your 401k if you might be “separated” from your employer in the near future.
Home remodeling projects not created equal. Do some online research (the Remodeling Magazine link at the beginning of this article has regional data) to determine which projects have the best ROI.
You may also want to check out comparable properties in your area to learn which renovations add the most — and least — to a home’s resale value.
And remember that what you pay to finance your renovations directly affects your ROI, because keeping costs down improves your return. It pays to shop for your financing, whichever method you choose.