Smart Remodeling Choices

Adding a backyard deck or updating a bathroom can do more than increase your living space. It can also increase your home's value.

The Early Show's personal financial adviser Ray Martin visits us on Thursday to tell us what improvements generate the best return on an investment, how to deal with a contractor, and how the government can help finance the venture.

While Americans may not want to risk putting their money in stocks right now, they are not hesitating to put money in their homes. Commerce Department data shows that home improvement spending rose 4.8 percent in 2001. And census figures show that homeowners invested $152.9 billion in improvements in 2000. That's up from $133.7 billion in 1999.

The fuel propelling this activity? A rapid rise in property values (in March, the median home price was up 6.7 percent from last year), interest rates at 40-year lows, and free-flowing home equity loans.

However, if you are treating your home as an investment, it's important to realize that remodeling doesn't automatically increase a home's value. All too often, people pour too much money into a project or make an improvement that doesn't resonate with buyers.

Projects That Make Sense

If you are thinking about remodeling, the National Association of Realtors says your best bet is a minor kitchen remodel. On average, the project will cost $14,773. Homeowners receive 88 percent of that money back when selling the home. Following are more improvements, the average cost, and return on investment.

• Minor Kitchen Remodel
  
• Average Cost: $14,773
  
• Return On Investment: 88 percent
• Bathroom Remodel
  
• Average Cost: $9,455
  
• Return On Investment: 85 percent
• Major Kitchen Remodel
  
• Average Cost: $38,769
  
• Return On Investment: 81 percent
• Family Room Addition
  
• Average Cost: $46,738
  
• Return On Investment: 80 percent
• Deck Addition
  
• Average Cost: $5,865
  
• Return On Investment: 77 percent
• Master Suite
  
• Average Cost: $63,275
  
• Return On Investment: 75 percent
• Attic Bedroom
  
• Average Cost: $31,366
  
• Return On Investment: 74 percent
• Home Office
  
• Average Cost: $10,526
  
• Return On Investment: 55 percent

That 88 percent return on minor kitchen improvements sounds pretty good. But in 1998, the return was 94 percent. Percentages across the board have slipped as the cost of the work has risen. This is yet another reason to be smart about your remodeling choices.

• Minor Kitchen Remodel
  
• In 1998: 94 percent
  
• In 2001: 88 percent
• Bathroom Remodel
  
• in 1998: 89 percent
  
• In 2001: 85 percent
• Major Kitchen Remodel
  
• In 1998: 87 percent
  
• In 2001: 81 percent
• Family Room Addition
  
• In 1998: 84 percent
  
• In 2001: 80 percent
• Deck Addition
  
• In 1998: 70 percent
  
• In 2001: 77 percent
• Master Suite
  
• In 1998: 82 percent
  
• In 2001: 75 percent
• Attic Bedroom
  
• In 1998: 82 percent
  
• In 2001: 74 percent
• Home Office
  
• In 1998: 64 percent
  
• In 2001: 55 percent

Location, Location, Location

The above numbers are national averages. However, there is no question that you will get a much higher return on your investment if you live in a competitive housing market. The following example is adapted from Realtor Magazine and Remodeling Magazine:

You can safely put more money into remodeling the bathroom in San Francisco than the bathroom in Albany because you are much more likely to get that money back.

When deciding what area to remodel or how much to spend, also check out other homes in your neighborhood. If most of the homes have three bedrooms and you only have two, a bedroom addition makes sense. You don't want a buyer to choose the house next door just because it has new kitchen appliances.

How Much To Spend

So how much should you plan to spend on remodeling? Again, consider your city's housing market and other homes in your neighborhood. Ask a real estate agent how much more she could get for your house once the project is complete. Find out what the average cost is for your improvement and get bids from at least three contractors.
But what if you don't plan to sell your home? Or you simply need a bigger family room or another bedroom? Do homeowners actually sacrifice their quality of life in order to safeguard one of their biggest investments - their home? No. But maybe they should. Let's say you spend $50,000 on a family room addition. Hopefully, you'll enjoy the space AND get that money back when you sell the home. But what if you don't? If the larger room only brings $15,000 extra to your sale price, was your enjoyment worth that $35,000? You could have used the money to buy a new car or help a child through college.

Choosing A Contractor

There are tons of horror stories out there about shoddy contractors, unreliable workers and projects running months behind. Every horror story also comes with its own expensive, over-budget, price tag. That's why it's essential to do your homework.

When writing a contract, most people know to include items such as the contractor's license number, description of the work and a start date. Here is a list of items that are sometimes overlooked:

• A List of Materials: Mahogany decking vs. pressure-treated wood, paint color and brand
• Description of Heavy Equipment Use: What will be used and how will operators access your property? (Bring it around the side yard, not through the flower beds.)
• Process for Changes: How and when will changes be requested and made once work has started?
• Warranties for Work, Materials: Attach the warranty that conforms to your state laws which provides for repair and replacement of defective materials.
• Clause for Dispute Resolutions: How will any disputes be handled?
• Payment Schedule: Specify total payments and partial disbursements for materials, phases of completion and final payment. Always pay in stages. Once you hand over the money, you hand over control.

The most common option is a home equity line of credit. The approval process includes an appraisal of the home value and can be approved and closed in a few weeks. There are no closing costs.

However, the government offers two loans that most people don't know about. Typically, they apply to lower-priced homes - either starter homes or homes in distressed areas.

Homeowners who have little or no cash or equity in their homes have a Catch 22 of sorts. They cannot borrow against their homes current value because they don't have enough equity but they would have enough equity if only 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 rate loans based on the expected market value of the home AFTER renovation. This special loan allows 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.

Once you've done all of this work, you need to protect your investment! Review your homeowners insurance; it needs to reflect the increased value of your home. Remember to cover the value of additional contents and landscaping, too.