Once
you decide to take the remodeling plunge there are
several steps you must take in order to prepare an
appropriate budget for the project. Your main objective
is to determine an amount that does not strain your
current and future financial resources but also provides
enough funds to accomplish the primary alterations
you need to make to your house. This article illustrates
the process for making this determination.
Your first step is to create a project budget. Decide how
long you plan on staying in your home. The length of time
you intend to stay in a home will affect how much money you
should invest in it. If you are going to stay in the home
for more than ten years, you should spend as much as you
are able to create the home of your dreams.
Make a list of all your debts. You should include any debts
you pay on a monthly basis, such as mortgages, car loans,
credit cards, and any other items with a fixed monthly payment.
This list should not include payments for groceries, utilities,
telephone services, or other general expenses. Call this
list your monthly expenses. Determine your total gross monthly
income. Include all sources of income that you would list
on a loan application.
You are ready to determine a project budget. Use the following
steps for this process; I have plugged numbers into the formulas
to demonstrate how each works.
STEP 1
Lenders use a simple Debt-to-Income (DTI) ratio to determine
if a homeowner can afford the additional debt of a remodeling
project.
| Enter
Your Total Monthly Expenses |
$2,860.00
|
| Add
the Estimated Monthy Payment for the Project |
$7,75.67
|
| TOTAL |
$3,635.67 |
| Divide
the Total by Your Gross Monthly Income |
$7,950.00 |
| DTI |
= 45.7% |
Each
lender will approve loans at a specific DTI percentage
(most lenders will tell you what their set DTI ratio
is, if you ask). In this example, let us assume that
the lender accepts DTI ratios of 45 percent. You are
right at the cusp of qualifying. Provided your credit
rating is good and you have plenty of equity in your
home you will most likely be approved for this loan.
STEP 2
The next step is to determine the maximum monthly payment
you can afford for remodeling. Multiply your monthly gross
income amount by the lender's maximum DTI allowance, and
subtract your current total monthly expenses, excluding
the estimated remodeling payment.
| Gross
Monthly Income |
$7,950.00
|
| Lender's
DTI ratio |
x.45
|
| Subtotal |
$3,577.50 |
| Less
Total Monthly Expenses |
-$2,860.00 |
| Maximum
Affordable Payment |
= $717.50 |
Use
this figure to determine the maximum available to you
to borrow. In this case we assume that the home improvement
loan is a fifteen year note at seven percent. The maximum
you can borrow is forty-seven thousand dollars for your
project given this monthly payment. There are many different
options you can explore with your lender during this
process. These options can sometimes increase the amount
you can borrow; it is best to discuss this thoroughly
with lenders.
STEP
3
The final consideration for your budget is if there is
any available cash to supplement what you borrow for the
project. These are funds not being set aside for future
financial obligations such as retirement, college, or other
major purchases (like a new car). They are not required
for monthly or general expenses as well. In this example
let us assume that you have three thousand dollars in excess
funds available for the project. This brings your maximum
project budget to fifty thousand dollars.
The budget now becomes the overriding parameter that drives
the project. Every decision from this point forward is
made according to the limits set by the budget. The next
thing to consider is the percentage of the budget necessary
for contingencies. Contingencies are unexpected items that
present themselves during the course of the project. The
guideline is to set aside between five and twenty percent
of your budget for contingencies. The actual percentage
depends upon the complexity of the project. For instance,
a new roof generally does not require other ancillary items
be repaired or altered in order to install the roof. Therefore
the minimum contingency of five percent is usually sufficient.
On
the other hand, a large addition to your home involves
many more trades and materials that likely require the
maximum contingency of twenty percent. As a rule if any
portion of your existing walls, floors, or ceilings must
be demolished or opened up in order to install the new
materials you need a contingency towards the maximum.
Although
a professional architect and/or contractor have vast
knowledge of the construction process he or she does
not have X-ray vision. Often times there are situations
that complicate construction contained within these areas
that cannot possibly be known about until the area is
opened. For our example we will assume you are putting
on a small kitchen addition (referred to as a bump-out).
Since you will have to open up an existing wall but the
work area is concentrated to a small portion of the house
a contingency of fifteen percent should suffice
This
means that the budget for actual construction that you
present to the architect is forty-two thousand five hundred
dollars. This is the parameter you want your design professional
to use. You hold the seven thousand five hundred dollars
in reserve to address any unforeseen expenses that occur
once the project begins. You protect yourself from scrambling
for extra funds in the middle of the upgrade; if you do
not use all of the contingency, and there is no rule that
says you have to, then you complete your project under
budget (heretofore an unheard of occurrence in remodeling)!
Your primary purpose for this exercise is to establish
a starting point for your project. You cannot proceed with
specifying the scope of your project without first having
a spending limit in place. This allows you to focus on
the inclusion of priority items in the project while eliminating
any "luxury items" that are not tantamount to your primary
goals.
Article courtesy of Brian Dineen / Residential Construction
Assistance Corp.
http://www.coach2build.com / bdineen@coach2build.com
