So youÂ’ve found the home you want to grow old in. The location is good, the neighbors are great, and the price was just right. Now like most homeowners in this situation you begin doing minor improvements or upgrades to your home. A little paint in a few rooms, wallpaper there, new flooring in this room, granite in that room, a fixture here a fixture there. Finally you are satisfied with your now remodeled home. Time passes and you decide you want to refinance for one reason or another. LetÂ’s assume you realized you could get a much better interest rate. (For the real truth behind current mortgage rates head to www.current-mortgage-rate.com) You tell your lender about all the upgrades in your home and how great it looks yada yada. Your lender goes on to tell you about how much equity you must have in your house and due to your great LTV they could let you cash-out some of that equity. Regardless of whether you try and task-out equity, your trouble comes when the lender goes to order an appraisal. The appraiser comes out and inspects your home and heads back to the office to write his report. After analyzing the data he realizes there is problem, your home is great . . . TOO great for your area.
Your house now becomes what appraisers refer to as Â“Functionally Obsolescent Due to Super-AdequacyÂ”. What this basically means is that the upgrades youÂ’ve made to your home are superior to the houses in your neighborhood and thus the law of diminishing returns has just kicked you in seam hard. No homes in your area have sold anywhere close to what your home SHOULD be worth and without comparable sales data to prove your homeÂ’s value youÂ’re stuck. An appraiser is not going to be able to give a value to your home any higher than the highest sale price in the area. This might not be terrible for some, but for those looking to cashout or with low LTVs this could be a deal killer.
The lesson here is to always know your market area which is usually defined as your immediate and surrounding neighborhoods up to 1 mile away. Know what homes sale for and what type of construction quality or amenities they posses before you start major renoations. If you must be Mr. and Mrs. Jones and over do it then be well aware of the law of diminishing returns.