Don't Rush To Remodel

Home improvement is big business.

Over the last 12 months, Americans spent about $155 billion sprucing up their homes.

And, according to The Early Show's resident financial guru, Ray Martin, remodeling seemed like an obvious choice over the past few years: Any money spent improving your home was sure to be money well spent. With home values surging and low interest rates on home improvement loans, it appeared home improvements were a wise investment.

But, Martin cautioned Wednesday, with home values stagnating, even falling in some areas, and home improvement loans that charge interest rates of eight percent or more, the home improvement value proposition has changed.

If you don't want to have your home improvement ending up being a gift to the buyer of your home, Martin said, you need to do a lot of homework before you spend a nickel on any sizable home improvement project.

He explained that several factors now equal a yellow light when it comes to remodeling.

Costs Likely to Exceed Value

While many homeowners continue to pour cash into home improvements, it seems that doing so, in many cases, is not a wise investment. The most widely circulated figures on the value homeowners receive on their home improvement investments come from the Cost Vs. Value Report published by the construction trade publication, Remodeling.

It considers construction costs and resale values across 58 markets, and estimates what various home improvement projects will pay back at resale.

Of the 22 home improvement projects analyzed in the report, only two — upper-range siding replacement and a modest bathroom remodeling project — appear to create more home value than what they cost.

This seems to indicate that most home improvement projects should be considered not as an investment, but as an expense from which some, but not all the costs can be recovered upon the sale of the home.

The implication of this is that, if there is a real possibility you could be selling your home in a few years or less, you could end up recovering only a portion of the cost of the improvement, and any costs not recovered are similar to making a gift of your cash to the people who buy your home, not necessarily a good thing to do.

Location Always Matters

Of course, like most things-real estate, the value of home improvement projects will vary widely from one local market to the next. The 2005 Cost Vs. Value Report showed that the value recouped for a given project can vary widely by region.

For example, the cost recouped for a major kitchen remodeling is 62.1 percent in Philadelphia and 105.1 percent in Los Angeles.

For this reason, it's important to consider the data for specific areas, which take into account local market conditions, rather than using national numbers.

Also, in areas where building lots and desirable homes are in tight supply, remodeling a home can still pay off. In areas where lots are less expensive or there is a more normal real estate market, remodeling costs are less likely to be recovered upon sale of the house.

Do the Research

Before you decide to put your money into a home improvement project, take a tour of similar homes in your local area. Ask a realtor to take you on a tour of a few homes listed for sale and even visit several new developments to see what features are included in newly-constructed homes. Also, consider the homes in your immediate neighborhood. If several of the homes were suddenly on the market at the same time, and your home was one of them, how would the improvement you are considering help to make your home stand out? Avoid any improvements that could be too unique, and consider those that are in line with most of the houses in your immediate location.

Also visit Realtor Magazine Online and review the 2005 Cost Vs. Value Report to see if your project is one of the 18 most reported home improvement projects. The limitation here is that the information in the report will only provide national and regional figures for the job cost, resale value and cost recouped.

Another very interesting tool is provided at Zillow.com. Using the "My Zestimator" tool on the site, you can actually get an estimate of your home's current value. The really cool thing about this tool is that it uses the data from the Cost Vs. Value Report for your local area and enables you to calculate the value of your home, including the value of any actual or planned home improvements, using local market data. Using this tool, you can create a refined value of your home that includes the increased value if you were to make a particular home improvement or upgrade. Their claim is that the tool computes the value of a home using local data from recent comparable sales, tax assessments, and many other sources, and employs a proprietary algorithm to come up with the value of homes in most markets where they can get the underlying data. If you are considering a home improvement project, using the tool provided on Zillow.com can be very helpful.Home Improvement Costs Rising

Anyone trying to get a contractor to work on their home improvement project will tell you that demand exceeds the supply of skilled and experienced workers to do the work. Combine this with rising costs of building materials and the high cost of home improvement loans, and many home improvement projects are likely to end up costing more. That has been the trend over the last few years. According to the average job costs published for 2005, remodeling costs have increased from as little as 11 percent for bathroom remodeling to more than 92 percent for deck additions. Some of these cost increases are due to new materials, such as composite decking and vinyl railing systems used for decks. In some cases, the higher cost of materials may be offset by lower ongoing maintenance costs.

Regardless, unless there is a significant slowdown in the economy and workers are willing to do jobs for less money, homeowners should expect to fork over more money next year for their home improvement projects. Some homeowners are using this rationale to justify going ahead with a project now, feeling it will cost more if they wait.

Planning Pays

Before getting swept up in the excitement of an addition or updated kitchen, homeowners should approach making a home improvement similar to the way they would making a sizable purchase or investment. Most home improvement experts agree that the key to a successful home improvement project is organization and planning. Define exactly what it is that you want done, get quotes and preliminary bids, and work up a budget. In short, do a lot of homework before you invest.

What to Get in Writing

If you plan to hire a tradesman or contractor for your project, it's a good idea to get bids or estimates from at least three qualified professionals. When there is strong demand for home improvement services in your area, this will be difficult to do, but don't skip this step. Check references, ask to see similar completed jobs, and request to see copies of general liability and workers compensation insurance certificates. Always ask for a written contract before you pay any money or begin work.

The contract should include these elements:

• Contractors name, address, phone number and license number
• Complete description of the work, including any diagrams and drawings
• A list of materials to be used on your project
• Complete costs and a schedule of payments
• Description of heavy equipment use and access
• Start date and completion date
• Process for changes during the project
• Written warranties for all work and materials
• Arbitration clause for dispute resolutions

Ask the contractor to obtain lien waivers from everyone who the contractor is responsible for paying. Also, make sure to get a full release and waivers of all materials and mechanics liens upon full and final payment. This is the best way to protect yourself from being slapped by liens from workers or suppliers who go unpaid by a cash-strapped contractor.

Contact a local lawyer for a list of specific contract issues, or www.nolo.com for general information and resources. Trust me on this. A good contract in advance will save you a lot of potential headaches later.

Paying for It

Here are several options to consider when financing your project.

Line-of-Credit:

The most common option used is a home equity line-of-credit. The amount of the line-of-credit is based on the value of the home in excess of the current mortgage amount, so you need to have more than 20 percent equity in your home. The approval process includes an appraisal of the home's value, and can be OK'd and closed in a few weeks. There are usually no closing costs, and you can draw on the line as needed to pay for the project. The interest rate is often tied to a percentage above the five-year Treasury note, or set to the prime-lending rate. Generally, home equity interest is tax deductible as an itemized deduction for loan amounts up to $100,000. In specific situations, this deduction may not be allowed. See IRS Publication 936, Home Mortgage Interest Deduction, for further details.

Refinance with Cash-out:

Consider refinancing your current mortgage with a new mortgage equal to the amount of the current loan and the additional cash you need for the improvements. This makes sense if the new interest rate is lower than the old rate, and is a good way to lock in your payments. There will be closing costs to pay, and the home's value must appraise within guidelines to allow for the new, larger mortgage. Compare combined interest costs of the existing loans to the interest cost and refinancing fees for the new mortgage.

Let the Government Help You:

Homeowners who have little or no cash or equity in their homes have a catch-22 of sorts: They cannot borrow against their home's current value, because they don't have enough equity, but they would have enough equity if they could improve their home. The U.S. Department of Housing and Urban Development backs two loan programs for homeowners in this situation:

Title I Loans

FHA Title I loans are offered by qualified lenders who provide loans for renovations when other banks will not lend because there is not enough equity in the home. These loans can be up to $25,000, with repayment terms up to 15 years. Often, there is no equity or appraisal required on loan amounts less than $15,000. The interest rate will be several percentage points higher than conforming mortgage or home equity loan rates, but people who use a Title I loan wouldn't qualify for traditional financing.

203(k) Rehab Loans

203(k) loans offer long-term fixed rates based on the expected market value of the home after the renovation. This special loan enables buyers purchase a fixer-upper property "as is" and provides the cash up front to perform the necessary work. 203(k) loans also feature low down payments of three to five percent. Check out www.hud.gov to find out more.

Protecting It

After a home renovation is complete, review your homeowners insurance. Since your home has increased in value, your coverage should be updated and increased. Your coverage should be at least 80 percent of the new replacement cost. This coverage amount ensures that partial losses are fully covered on a replacement cost basis. To be fully protected on a total loss, you must insure to 100 percent of the replacement cost. If you carry less than this minimum coverage, you'll receive payment for a percentage of the loss based on the percentage of the coverage bought versus the required limit. Remember to cover the value of additional contents and landscaping, too.

Keep Score

Finally, keep a record of the cost of all remodeling and improvements to your home. These costs increase the amount you can subtract when figuring your profit or gain on sale. With the tax rules allowing married filers to exempt up to $500,000 of home sale gains (and $250,000 for singles), it's likely that many people may never again pay tax on gains from the sale of their home. But, hey, you never know.