With home prices soaring and inventory of homes for sale at record lows, many families are looking inward to their existing home to see if revitalizing what they already have can be changed to suit their needs. The task of even thinking of ripping open your home may be too much for many. If you break the process apart in bites, it becomes much easier to handle.

The first step is to determine if you are happy with the location of your home. Most people like their current neighborhood. If you’d rather move, don’t give a second thought to renovation. If you don’t like where you’re at, you could renovate and have the best house ever – but if you don’t like the area or commute, it still doesn’t make sense.

But maybe your home is in a nice area, you know the neighbors, and the commute isn’t too bad. I have to chuckle writing this, because if you live on Oahu, the commute is terrible for almost everyone, and unlike when I grew up in Nuuanu 40 years ago, nobody today is close with their neighbors. But let’s not digress. Let’s just go with the thought that you’re okay with where you live. Step number 2 is to determine if you were to update your home, what things are you unhappy with. The headline for the article is about having a new kitchen, but bathroom renovation, especially if you have older family members that may need an ADA set-up, is something not to overlook.

Once you’ve made your list of wish items, don’t call the contractor right away. Let’s talk about how you’re going to pay for it.

Renovations are generally paid for through equity in your home. The deciding factor from this point forward is determining if you already have sufficient equity in your home now, or if you have to create it through the renovation.

Do you have enough equity now?
Many older homes with multi-generational families living in them are sitting on a lot of equity. Also, if you’ve had a mortgage for a while and been paying it down, you’d be surprised how much equity you have. That equity can be easily accessed to fund the renovations. Do some research of what similar homes in your area selling for. Use that value as a starting point for your math exercise. Let’s say you determine your house is worth $900,000. To determine your available equity, take 80% of that figure, which is $720,000. Subtract from the $720,000 all mortgages, including if you have an existing Home Equity loan or financed PV system. For our example, let’s say that the existing debt is $600,000. That leaves you $120,000 of equity to tap into.

If you’ve determined you have sufficient equity for your renovations, you have a couple of financing options. You can either seek a new 1st mortgage as a cash-out refinance, or keep the current 1st mortgage in place and get a Home Equity Line of Credit (HELOC). For most people, funding renovations through this mechanism works best because you have the cash in hand prior to starting the job. Which of the 2 options is best for you? It is determined by what rate your current 1st mortgage is at, how much cash are you pulling out, and the terms of the HELOC. Your mortgage professional will be able to assess your needs and present the options. You can then make a rational decision on which path works best for you.

Not enough equity to tap into?
Let’s say you bought your home a couple of years ago with less than 20% down. And now with values jumping, you just got to the point where you can get rid of that mortgage insurance. Or maybe you have equity, but just not enough to do everything you want to accomplish. For you, the renovation takes on an added calculation. How much will your home increase in value with what you plan on doing?

When you don’t have sufficient equity, you’ll have to manufacture equity by increasing the value of your home based on the renovations you make. When applying for these renovation/construction loans, the appraiser will base the value of your home on the as-completed value, versus what it’s worth today. If you’re looking to add square footage, an extra bathroom, or bedroom, that will certainly increase the value of your home. Like in our calculations above, the maximum loan amount is generally 80% of the appraised value. Do the same math exercise using that new value and subtracting out your existing debt against the home. Hopefully you have manufactured the equity you need.

Construction financing has come a long way in the 25 years I’ve been doing it. The rates used to be terrible because of added risk to the lender. The loan costs were expensive, again due to risk. But today, the One-Time-Close construction loan is a great mortgage product. Rates are just slightly higher than a regular mortgage loan. And unlike in the past, this is one loan that takes you all through your construction then automatically turns into a 30-Year or 15-Year amortized loan – all at the same rate.

There are a lot more steps in obtaining a construction loan versus just tapping into your equity. Construction loans require the use of a General Contractor and a Completion Bond is required. That gives you less flexibility, especially if you’re looking to family and friends to do the work. The bank will also require plans and your approved building permit.

Regardless of the path you take to update your home, I want to stress the most important thing you should not skip – get a building permit and make all your renovations legal. If you ever must sell your property, do you want to deal with an appraisal coming in low because portions of your home were done without a permit? Especially in today’s upwardly moving market, appraisers are having a tough time meeting the sales value to start with. Subtract out the unpermitted improvements, and there could be a big chasm between what you are selling your home for and what the appraiser values your home at.

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