Understanding the current lending guidelines can help you make smart decisions regarding home improvement projects.

What? How do the lending guidelines have any influence on my master suite addition?

As you most likely are aware of, lending guidelines have changed and many loan programs have been eliminated entirely. Not that this is necessarily a bad thing but the rules have changed nonetheless. Having a clearer picture of where things are at now will help you make a smart decision regarding the potential payback of a project that you may be contemplating.

A few years back it seemed silly to even question the thought of scaling down or even forgoing a home improvement project based on recouping the costs. It was assumed that whatever money you spent on improvements could be added to the resale value of your home with a little something extra in appreciation to boot. Not any more.

Now I’m not saying that you shouldn’t spend any money on your home and that nothing you do will increase your home’s value but the following things should be taken into consideration:

1. What is my home’s value prior to the improvement(s) I am contemplating?

The answer to this question will be approximate but there are several options out there. Obviously you can have a professional give you an opinion via an appraisal or a CMA from a Realtor. Another option would be to check out the automated home value estimates from Zillow, Realtor.com, and Cyberhomes, among others. A word of caution to owners of older homes… these sites can be off by literally $100,000 on values as they are typically crunching numbers based on sales records and price per square foot in a given zip code. As many of you know, price per square foot can be a lot less of a factor with a historic home. That 1200 sf foreclosure in Chaffee Park registers as a comp to your painstakingly restored Harkness Heights bungalow in these automated systems.They are a starting point if nothing else, but certainly are no substitute for a professional’s opinion.

2. What is the cost of the improvement in question?

Are you contemplating a minor kitchen remodel or a major addition to your home? Are you going to be doing the work yourself or hiring a professional? Getting a realistic idea of your project costs will be essential to making a smart decision. Adding in a little fluff when it comes to the budget is always a good idea as well.

3. Where does my home sit with regards to the price range the market will support for it’s given size and feature set?

Depending on your neighborhood this answer can be relatively easy or incredibly difficult. If you’re in a newer home or condo you can look at current sales activity for a given finish level, size, and bed/bath count and make the call pretty easily. If you’re in a 100 year old Potter Highlands Victorian it’s a whole different story. If possible, it would be best to get a professional’s opinion in this situation. The idea is that if your neighborhood is supporting a price range between $350,000 and $500,000 for a 4 bed, 2 bath home and you paid $485,000, be aware that you’re already at the upper end of what a buyer is willing to pay.

4. What, if any external factors could limit my home’s value in the current market place?

Back to the title of this post… given the current tightening of the belt that’s going on across the board for lenders and their underwriters you would be wise to at least be aware of the following: the maximum conventional conforming loan amount that will be sellable on the secondary mortgage market is $417,000 and the current FHA loan limits are typically slightly less.

For Denver, the current FHA loan limit for a single family residence is $406,250. With a minimum down payment required being 3.5%, funding will be readily available for anyone with verifiable employment, income, and assets to bring about $20,000 and make a purchase up to $420,000. Anything above that purchase price and the buyer will need to bring the extra money in the form of a larger down payment.

For the conventional loan programs, typically the minimum down payment is between 5% and 10% depending on your ability to meet credit and financial guidelines. With a maximum loan amount of $417,000 and a 5% down payment a buyer could max out their purchase price at about $439,000. At 10% down payment a buyer could bump their purchase price to about $463,000. Again, anything above and beyond these numbers needs to be brought to the table by the purchaser in the form of more money down.

Let’s pull this altogether now.

So now that you have an idea of 1. your home’s current market value, 2. the approximate cost of your proposed improvements, 3. Where your home currently sits in it’s price range, and 4. What external factors might influence the ease of selling your home we should be able to make the best decision regarding improvements and their potential for adding tangible value.

As an example, we can go back to the scenario of having purchased your home for $485,000 back when the easy money was still readily available. It’s been about 18 months and you’re contemplating the master bath that you said would be so easy to add. If the project is going to cost you $20,000 your basis in the home (not including any other improvements you may have already made) is now at $505,000. If homes in your neighborhood are selling for up to $500,000 for a 4 bed, 2 bath home one would think you’ll be just fine with an extra bath and a basis of $505,000. Most likely you will be. But it is worth noting that the young professional couple fresh into the workplace may want to buy your home but at this juncture they’ll need to bring at least $88,000 to the table to do it.

In conclusion…

I will expand on the idea of our local market segments moving in different directions based on their price points and proximity to the conforming/FHA loan limits in a new post shortly. The idea itself is very much a reality at the moment and our upcoming market statistics post will illustrate the principal in North West Denver real estate as an example. The question remains how pronounced the difference in market activity will be on either side of the dividing line but as the economic worries continue I would bet that lenders won’t be getting any benefit of the doubt on underwriting guidelines.