Is Buying a Fixer-Upper Worth It?

What Is a Fixer-Upper?

In most cases, a fixer-upper is a house that needs to be remodeled after it’s been purchased. This is subjective and depends on the level of upgrades you intend to make.

One rule of thumb suggests you spend approximately 20% to 25% less than what a property in good condition in the area would cost. When you search for a fixer-upper look at things like the price per square foot and the number of bedrooms and bathrooms.

If the house will need substantial repairs to the roof, electrical or HVAC system, do the math.

Cost Analysis

Add up the costs to renovate the property based on a thorough assessment of the home’s condition. Your estimate should include materials and labor — yours and paid professionals. Subtract that from the home’s likely market value after renovation obtained from comparable real estate prices in the neighborhood. Then deduct at least another 5 to 10 percent for extras you decide to add, unforeseen problems, and inflation. What’s left should be your offer.

Make sure the real estate contract includes an inspection clause to assure that the house is a good investment or to help you back out of the deal.

Consider hiring specialized experts to perform in-depth inspections of any trouble areas identified such as a structural engineering evaluation, sewer line inspection, pest inspection, roof certification, etc. Most often, any issues will be an opportunity to negotiate the sale price.

Choosing a Fixer-Upper

The number one rule in real estate is location, location, location and the same applies to a fixer-upper.

For maximum resale value, remodeling investments should not raise the value of your house more than 10 to 15 percent above the median sale price of other houses in your area, according to the National Association of Home Builders.

Fixing a house in a neighborhood where all the other houses are in need of upgrades, may not be a good idea, at least in the short run. Fixing a house in a more desirable neighborhood could end up being a better value. Your real estate agent can help determine the value of a home’s location.

You can easily replace hardwood floors and upgrade kitchen cabinets, but structural issues are much harder to address.

In between structural and cosmetic renovations are major additions needed to bring the house in line with other homes in the neighborhood, like adding a great room or third bedroom. These projects usually cost as much as or more than their return in market value. An exception is adding a bathroom, which can be worth twice as much as its cost.

Sometimes it’s possible to fold cosmetic improvements into a structural repair. You may be able to add a skylight when replacing the roof or install a bay window when repairing a wall.

A large-scale renovation job can take many months, if not years, to complete, and if home prices fall, you might end up with a house that’s not worth your investment.

Renovations Require Time and Expertise

Unless you have experience in construction and renovation, you’ll most likely need to bring in the experts.

Depending on the type of renovation, you may not be able to live in the house while repairs are being made. If so, be sure to budget for the cost of staying at a hotel or other lodging for the duration.

Whatever renovation is required, it’s usually most cost-effective when you can help with the work. Even if you’re not interested in tearing down walls, be prepared to devote a considerable amount of time to supervise contractors. If the project goes over budget because of mistakes or unnecessary delays, it can add considerably to your final cost.

Financing the Project

For small projects, credit card debt is an option but interest rates are high and the interest isn’t tax deductible. On the plus side, there are no up-front costs, such as appraisal and origination fees.

It’s also possible to borrow against the cash value in a retirement plan, life insurance policy, or stock portfolio. In each of these cases, there’s no credit check and the interest rates are relatively low but the interest is not tax deductible.

The most popular choice is a renovation loan, either through a home equity line of credit or a mortgage. Home equity lines can generally be borrowed against 90 percent of the equity of the home after repairs and remodeling are completed.

More advantageous is when a renovation loan is tied to the first mortgage. Similar to equity lines, these loans can be borrowed against the house’s value after the work is finished, and like mortgages, the interest is tax deductible up to $1 million.