Taking Advantage of Fed Cut Interest Rates
On March 11, Bankrate posted that the interest rate for mortgages is down to 3.76%.
Mortgage rates have been dropping to historical lows in the last week in response to the market and the international spread of the Coronavirus.
But every cloud has a silver lining, and right now, that silver lining is spot on for homeowners and new buyers.
With interest rates now the lowest in recorded history, it’s a terrific time for homeowners to consider refinancing and for potential new homeowners to lock in the savings on the purchase of a new home.
But with low housing inventory across the nation, which option would be best?
I evaluated the cost and benefits to purchase a new 3/1.5 with sunroom, extra den, or office (or a 4/2) to add on to an existing 3/1 to make the space adequate.
Refinance To Remodel – A Case For Cash-Out Mortgage Refinancing?
Backstory – Original Purchase Price
In 2009, I worked with a great local realtor. I bought a small 3 bedroom, 1 bath house 10 minutes from a major city for $65K. It was an amazing deal – even then!
The home is about 1,000 square feet and was a perfect starter home. I wanted something nice, move-in ready, in a safe neighborhood, near a shopping center, near parks and recreational activities, and not far from Downtown. I also wanted something with a bit of woods and not too pricey.
I wanted something I could make the payments on easily, even as a family of 3 or 4 on one income if we ever decided to go that route. Why?
1) I really like and value family time and
2) in 2010 the market was still in recession.
I liked the security of being able to know that I could afford this house even if things got tight.
And…the location had A LOT of potential. It was situated in between two growth cities and very close to a popular local and tourist attraction.
The house was a great buy.
We have lived in it, rented it out while we toured the USA in an RV for a year, and moved back into it after our travels.
It is a steady property in a steady neighborhood – occasionally income producing.
Market Now Update
Since my initial purchase, housing prices in that area have more than doubled.
I currently owe around 52K on this house with an interest rate of 4.875%.
I could, if I wanted, pay this property off quickly now in under a few years and turn it into a rental property.
But…we need more space.
With a family of 4 now, the one bathroom thing is getting a bit old.
We have two choices – buy a new home that fits our needs, or remodel this one to fit our needs.
Future Plans – Updates and Renovations
Three bedroom, one bath houses around 1,000 square feet currently top out at around $125-180K for this area.
We had previously considered remodeling it to make it 4/2 or at least a 4/1.5 bath to make the space work, but a HELOC mortgage on top of the existing mortgage wouldn’t make sense.
The HELOC would have added roughly $800/month to our current $600/month mortgage payment. We would have been around $1400/month for a little 1,200 square foot home.
While that may be inexpensive for many areas of the country, South Carolina is not there yet… thankfully.
For that same payment, we could buy a brand new 4/2 or 4/3 home around $250-275K with a yard, 2,000-2500 sq ft, and it would likely come with a garage.
The math didn’t work in our favor.
As Robert Kiyosaki would say, “It wasn’t a good deal.”
Taking Advantage of the New, Lower Mortgage Rate
With the new interest rate being lower than our current mortgage rate, and with the property value being more than double what we paid due to low inventory, in comes a new opportunity – a cash out refinance loan.
We can borrow up to 80% of the LTV ratio, and with an appraisal of around $120K or better, we could get a loan for up to $95K. If the house appraised for closer to $135K+, we could get an additional $15K.
We only need $30-40K for the addition.
To update the home across the board – new doors, update floors, etc., we would need an additional $10-15K.
Total cash needed: $40-55K.
But does it make sense?
What We Pay Now VS What We Could Pay
We currently owe $52k at 4.875%.
Our PITI payment is around $600/month for a 3/1.
Refinancing this property for 30-years at 3.78%, adding on the additional $50K for an addition and renovations would look like this:
- With the lower interest rate, and adding this extra $50K to the mortgage this would raise our monthly payment about $80-90/month ($1,080/year).
- For an extra $90/month we could add an 150-200 square feet, including a small half-bath, create a new parking area, reside the house, lower our homeowner’s insurance, and do a heavy update throughout the home.
We could have a super cute 3/1.5 Craftsman style home with around 1250-1300 square feet.
- By expanding the living room area, we could potentially also move our home office out of one of the bedrooms, freeing up a bedroom.
- The new mortgage payment would sit around $680/month for a home in a safe neighborhood, off the main road, with low traffic and a fenced in yard. (I used Bankrate’s PITI calculator to get a rough number here.)
- With the interior remodel and updates, the property value would increase to around $200k, based on neighborhood comparisons of homes in this area for a similar size with similar lot size. The rental income potential would also go up.
If we decided to sell the property in 6 months to 2 years, and the housing prices maintained or trended up, we could profit roughly $100K, which we could roll over into other investments or the purchase of another home.
Plus, we have a super cute home to live in during that time for only an extra $80-90 month!
Potential Loan Amount: $100,000
Potential PITI payment: $680/mo
Potential Sale Amount: $200,000
Potential Profit: $90,000*
*Profit does not include what we have already paid for the 10+ years we have owned this home or renovations we have made to date.
Interest, taxes, insurance paid to date: $24,000
Principle paid to date: $41,278
Updates/maintenance to date: $10,000
Total invested to date: $75,278
Net Profit at Sale: $14,722
Average Net Profit Over Lifetime of Property (assuming 12 year residency and sale for profit stated above): $1,226/year
That’s not terrible, getting paid a little over $1,000 a year to live somewhere for 12 years, but there’s greater earning potential out there.
We could do the reno, and then sell the property shortly after, moving the profit over into investing in other areas, like the multi-family unit with passive income potential.
In the end, it only makes sense to do the reno if we intend to stay in the property for a time, allowing us the benefit of a 4/2 house with a double wide payment.
Otherwise, we could sell the home with a few minor updates now, without going through the hassle of an addition and remodel, cash out and make a $100K profit as is.
That is still to be determined.
To learn more about the awesome power of cash-out refinance loans, check out this article on cash out refinance loans by Bankrate.
When Cash-Out Refinance Loans Make Sense
According to BankRate.com, cash out refinance loans make sense when you:
- Get a lower interest rate on their mortgage.
- Make value-added home improvements or repairs to your home.
- Consolidate and pay off high-interest debt.
- Help pay a child’s college tuition.
Our house fits the profile for points 1 and 2 nicely, but your scenario may be different.
When cash out refinance loans don’t make sense:
- Increases the interest rate of your existing mortgage.
- Reestablishes private mortgage insurance, or PMI.
- Drags out the repayment of an existing debt for decades.
- Heightens risk of losing your home.
- Tempts you to use your home as a piggy bank.
I’m okay to “drag out” the repayment of this loan because I am entering with an exit in mind.
I am entering with the idea of selling the property for potentially 2X and using that profit to enter into the multi-family market.
In the interim, the changes could potentially allow our family an added degree of comfort and room to grow.
Now I just need to use the data at hand, and evaluate potential growth areas to compare and contrast to determine which buy would be a better real estate investment for our family – monetarily but also to help us better reach our goals as a family.
How do you feel about cash-out refinance mortgages?
Are they a good deal or not?
How and when would you use one?
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