Today’s front page Courant article gives another view of the refinancing opportunity. They highlight a homeowner who is moving from a 30 year to 15 year mortgage, illustrating the significant amount of interest they can save by knocking 8 years off the total term of the loan. The story provides another great example of the line of thinking and analysis we did when working through our refinancing process. And kudos to the homeowner for aspiring to pay it off even earlier.
Although the article is definitely in line with our thinking, there are a couple of statements that concern us. So we thought we would write a quick companion piece.
The homeowner used in the example paid $213,000 in 2006, but was told today that she shouldn’t list her home for more than $218,000. She said, “I would have lost money on the deal.”
We’ve unfortunately been seeing homeowners talk about “losing money” on their real estate a lot recently, but they often mean very different things. Some look strictly at the price they paid versus the price they expect to get in a sale. Others will add the cost of their improvements to the price they paid and then compare that to what they expect to get in a sale. And still others will deduct the transaction costs from the expected sale price before comparing to their cost.
We think that the correct cost to consider is the purchase price plus the cost of improvements. And the appropriate value for the house is the expected sale price without deducting the transaction costs.
That being said, homeowners shouldn’t expect to get all of their money out of improvements. Part of the reason is that many improvements are actually maintenance costs – keeping a home in proper working condition – and maintenance costs have very little value to potential buyers since they expect a home to be in proper working order. Even projects that are truly enhancements to a property typically don’t pay back at 100%. The main reason is that we design to our own personal tastes, which are usually different than that of others. Swimming pools are a classic example of an improvement that is owner-specific, but on a smaller scale it’s things like the choices of cabinets, counters, tile, and other long-lasting decorative elements. As homeowners we have to factor in the enjoyment we get from living in a space that feels inviting to us.
“Looking back, [homeowner] knows that she paid too much when she bought her first house in 2006.”
Prices and markets have to be evaluated in the moment. This statement could be true, but the only way to tell would be to analyze data from 2006 to see if the price she paid was in line with what other comparable homes were selling for at the time. That’s one of the main benefits of working with a real estate agent – they can analyze the data to make sure the seller’s asking price is reasonable.
We’re finding that some owners are comparing values in the current market to what they paid years ago and concluding that since the value of their home has not increased they must have overpaid. Residential real estate markets have changed considerably over the past few years, so it’s quite possible that a property that was a great buy in 2006 is now worth less than its purchase price.
If she holds the home for another 20 years, will she still feel she overpaid?
Factor in inflation, depreciation, and interest (even adjusted for the mortgage-interest deduction) and it’s hard to believe anybody makes money on his or her home. Sure, the home may be worth more in 20 years,* but given Connecticut’s stagnant growth, it will be purely due to inflation.
*In 1988, the previous owner of our home paid the equivalent of $520,000 in today’s dollars. We paid 40% less than that 20 years later — and think of all the carrying costs.