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Hypothetical but not totally unrealistic situation:

Looking at recent comparables (and non-comps like smaller homes or fewer amenities), the value of homes in my neighborhood have increased dramatically. My 1.5-story 1675 sqft 4-2 home used to be the most expensive on the block at around $136k and everything else was listing in the $90s; now, with the economy picking up but money still cheap, other houses in my neighborhood are changing hands at contract prices approaching a quarter-million.

Now, we bought in 2010, and didn't have enough for a conventional mortgage so we went FHA and are paying a PMI on our current note. I expect, in the next couple of years, to be able to spend $10,000 on my home. The question is, how best to use the money?

  • Option A: We could use the money to pay down our mortgage directly. $10,000 off our principal wouldn't quite get us to 20% and allow us to lose the PMI, but it would drop the P&I chunk about $50/mo and get us within a few thousand of 20% based on the sale price; we could then make a couple extra payments from there and lose the PMI based solely on equity of sale price.

  • Option B: We could use the money to fix and/or upgrade some things in the home that were part of the original bill of sale (like a hot tub in the back yard that raised the list price way more than it should have given its condition), along with further improvements or repairs such as updating the kitchen and bathroom. Then, we hire an appraiser, he prices the home, and any increase in the value over the purchase price is pure equity for us; if the appraisal reflects neighborhood price increases, we could end up with better than 50% equity.

    However, there is a chance that the appraisal could come in at something less than a figure that would give us 20% equity. It's not a likely scenario IMO given what the neighborhood's doing, but not impossible. Then we've spent $10,000 and still have the same housing payment, plus the appraisal will be reported to the tax appraisal district and be used to calculate our tax bill, so we could pay the money and see our housing bill increase further.

Of the two, Option B seems more palatable; the assessor is going to look at the surrounding homes' sale prices anyway, and adjust our home's assessed value upward by as much as he can (State law restricts tax base increases to 10% over the previous year's assessment, which for my house is still below the sale price) for 2016. So, we might as well get a number for the home's true value that will let us drop the PMI even if it'll be offset by increased property taxes. In addition, our credit's improved since we bought the house, so in the re-fi or streamlining to drop the PMI we could also negotiate a lower rate.

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    'Not every type of home improvement adds substantial value to your home. In fact, many upgrades don’t even bring you any return beyond what you spent making the upgrades.' - moneyunder30.com/pay-off-private-mortgage-insurance-pmi-9376 Be warned though: Wasn't that long ago that people refinanced on their new appraised values and brought us into a world of hurt ;) – Ross Oct 5 '15 at 19:42
  • True, however housing values are on the rise from depressed levels of the last 6-7 years, and we're not looking to re-fi to cash out equity, we're trying to reduce expenses inherent in the existing mortgage which would lower ROD (and we'd have a nicer place to live in the bargain). There's also a possibility of moving closer to where my kind of work gravitates in the DFW metro, and if we do that we'll need every dollar of equity we can get out of the house when we go, so some of the work being considered would be inherent in staging the house anyway (patching, painting, landscaping, etc). – KeithS Oct 5 '15 at 19:59
  • Would do some online searches for the best bang for your buck into the house. Looks like exterior cosmetics (new door,paint,roof,landscaping) add decent value per $$ followed by bathroom and then kitchen. Remember though, increasing the appraisal value will not actually add any more equity: it will just change your LTV and allow the PMI to come off...thereby allowing you to start putting more of that $ into equity in the house. It will increase what you receive in the selling price though - you are probably thinking of it from that direction. – Ross Oct 5 '15 at 20:03
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    I'm defining "equity" here as the value of the home not offset by collateralized loans, which you're calling LTV; increasing the value of the house doesn't lower our loan balance or pay it off sooner, I'm aware of that, but if we don't take out loans to effect that increase, the rise in value is ours, not the bank's, so we "own" a larger percentage of the house, so the PMI comes off and we have more money to take away from this house and put towards another if we should move. – KeithS Oct 5 '15 at 20:09
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    Lowering what's owed on the mortgage will not drop the monthly payment. You're stuck with it until you can get the PMI dropped or refinance. You should also check that you can drop the PMI once you get to 20% and that's it's not after X number of payments. – mkennedy Oct 5 '15 at 21:19
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There is no guarantee improvements will raise the appraised value. You also don't want your property tax appraisal to go up if you can avoid it. Since you are talking on the order of $10k I'll assume you're only a few thousand dollars more from getting to 20%. That said, any schemes you might come up with like refinancing or second line of credit will probably cost more in fees than they are worth, unless you can get a much nicer interest rate.

Figure out how long you plan to stay there, Evaluate your options (do nothing, principal reduction, refinance for 30, 15, or even an ARM) and figure out your bottom line by comparing everything in a spreadsheet

One more thing: if you do pay a substantial amount of extra principal, you can ask the lender to "rebalance" which will correct the minimum monthly payment to your remaining term. This will likely incur a fee, but could be helpful in an emergency

  • Thanks for the answer. There were some facts I didn't state; because it's "MIP" and not "PMI" because the loan is FHA, it comes off on a schedule based on the purchase date of the house; before 2013, MIP will come off when the LTV ratio is 78% or less, except that LTV is calculated based on the last price the FHA knows (which is the appraisal we got to buy the house). The FHA won't just come out and appraise a house like an independent appraiser will, so improving the home's value doesn't help remove the MIP; we have to pay 22% of the 136k or else re-fi to a conventional mortgage. – KeithS Oct 26 '15 at 17:42

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