Recently, my mom and stepdad decided to remodel their house using all of their home equity -- against my expert real estate advice. They dug into every dime of their home value, over improved their property and loved what they did with the place, all in the hopes of selling it for a huge profit. That is until they realized that they were never going to get what they paid for.
Costly Mistakes
Their home was worth $329,000 in the Nevada market. Their mortgage balance was $264,000 before they chose to remodel. They took out $60,000 of their equity (leaving them with $5,000) to pay for a plethora of upgrades. That left them with their regular mortgage payment on a fixed rate 30-year note, plus a $60,000 second mortgage at 7.5 percent APR.
Why Over Improvement is Never a Good Idea
Rather than looking at what other homeowners in the area had done, they went all out with the improvements to their home. They bought new stainless steel appliances, added custom features, elaborate tile backsplashes and do-dads galore. By the time all was said and done, every dime of the $60,000 was spent.
Putting the House on the Market
Almost immediately after the contractors completed the upgrades, they put the house on the market. They thought that adding $60,000 worth of improvements to their home they could justify a sales price of $389,000. However, the market thought differently.
The Market Is, What the Market Is
Since they had over improved their property to the tune of nearly $35,000, the most they could hope to get for their sale would be $364,000. However, according the market, their house was actually only worth about $350,000, post improvements. After commissions, fees and closing costs were paid, they were looking at a final net price of $315,000, meaning they would take a loss on their home once their first and second mortgages were accounted for.
What They Should Have Done Instead
What I do (and what I told them to do) was to set aside one percent of my home's value each year to allocate to maintenance and another one percent for home improvements. After nearly eight years of owning my home, I have set aside $20,000 for home improvements, allowing me to add new fixtures, redo some drywall, update my kitchen (or whatever else my little heart may desire), all without dipping into my home equity.
My savings for home improvements have always been separate from my savings for my emergency fund, my maintenance fund and any other savings account I have. While it takes discipline and structure in my budget, it's paying off in the end.
My "Sale" Scenario
Today, my mortgage balance is only $40,000, and my house is worth $156,000. If I added $20,000 worth of upgrades (in cash) and sold my house for a bargain basement price of $170,000, I'd walk away with a little more than $113,000 profit after real estate fees and closing costs.
In my humble opinion, dipping into my home equity is never a wise move. I prefer to live a cash only life, because it pays off in the end.
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