Refinance before or after remodel on inherited house

[Kaitlyn Masai]

Hello BP, 

I have a tricky situation that I could use some guidance on. My family just inherited a house in Marina, California. This house was previously by my uncle and his partner both of whom passed away in the last 6 months. The house was purchased for $476,000 in 2008. There is $7,700 in equity in the house and there is about $330,000 still on the loan. The house right now is a SFR (3 bed, 2 bath) and the value that I have found online range from $373,000 to $511,000 but generally seem to be close to $450,000. This house needs new flooring, a new toilet, minor cosmetic upgrades, and the backyard needs to be completely rehabbed. Additionally, there is a back house that was in the process of being remodeled. It is basically a studio apartment with a working bathroom but no kitchen. We want to rent the house out and already have a potential renter. My first question is should we refinance now or wait till after its is remodeled?

One problem here is that the house was owned by my uncle and now is owned by my mother through a transfer on death deed. However, my uncle didn't have a chance to transfer the loan to his name before he died. So the loan is in his partner's name and owned through a different executor. We've spoken to a lawyer about this but he was almost as confused as we are because apparently this transfer on death deed is very new.  

The second part of this is about the renter. This renter was renting from my uncle's partner but the house he was staying in is being sold. He wants to move into this house we inherited. He is known through my uncle's network as a good renter (never missed a payment, has been renting there for 8 years, and does repairs on their other properties). He offered to remodel the house for free in exchange for a discount on the monthly rate for the duration of the repairs. The house as a SFR could rent for $2,600. We would discount rent to $2,000 for about 6 months. Is there a way to do this and legally protect ourselves? Or is this just a huge risk?

[Jerry Padilla]

@Kaitlyn Masai 

To answer your question, refinancing after the repairs are made would be best. The house had to be in livable working condition to refinance. The property in the back, will need the kitchen done. Are you looking to pull cash out or just refinance? 

[Kaitlyn Masai]

@Jerry Padilla  

Thanks for the advice. Just refinance for a lower monthly payment. There is only about 7k in equity in the house. 

[Jerry Padilla]

@Kaitlyn Masai

What do you mean by only $7k in equity? To refinance an investment property, you need 75% LTV - 25% equity according to the current appraised value of the property, for conventional financing, at least. This is even if you don't cash out on the property.

If there is a $330k balance and you think the property is worth $373k-$511k that is more than $7k. You would need the property to be worth about $412.5k to cover the refinance and a little more value to cover the closing costs for the refinance as an investment property. 

[Albert Bui]

Originally posted by @Kaitlyn Masai:

Hello BP, 

I have a tricky situation that I could use some guidance on. My family just inherited a house in Marina, California. This house was previously by my uncle and his partner both of whom passed away in the last 6 months. The house was purchased for $476,000 in 2008. There is $7,700 in equity in the house and there is about $330,000 still on the loan. The house right now is a SFR (3 bed, 2 bath) and the value that I have found online range from $373,000 to $511,000 but generally seem to be close to $450,000. This house needs new flooring, a new toilet, minor cosmetic upgrades, and the backyard needs to be completely rehabbed. Additionally, there is a back house that was in the process of being remodeled. It is basically a studio apartment with a working bathroom but no kitchen. We want to rent the house out and already have a potential renter. My first question is should we refinance now or wait till after its is remodeled?

One problem here is that the house was owned by my uncle and now is owned by my mother through a transfer on death deed. However, my uncle didn't have a chance to transfer the loan to his name before he died. So the loan is in his partner's name and owned through a different executor. We've spoken to a lawyer about this but he was almost as confused as we are because apparently this transfer on death deed is very new.  

The second part of this is about the renter. This renter was renting from my uncle's partner but the house he was staying in is being sold. He wants to move into this house we inherited. He is known through my uncle's network as a good renter (never missed a payment, has been renting there for 8 years, and does repairs on their other properties). He offered to remodel the house for free in exchange for a discount on the monthly rate for the duration of the repairs. The house as a SFR could rent for $2,600. We would discount rent to $2,000 for about 6 months. Is there a way to do this and legally protect ourselves? Or is this just a huge risk?

HI Kaitlyn,

I was trying to wonder what you meant by only 7k equity as well since I think the prior response was also asking this same question.

Did you mean after your anticipated rehab cost (330k loan + potential rehab cost for materials) that you have 7k left  based on the value you have estimated? (lots of varibles here, needs more clarity)

To differentiate the questions you've asked I'll label them so that appropriate views on the question can be addressed such as the question about whether you should do the upgrades first or refinance first. This is an investor centric question and a lender question because you'll have to know the market before you figure how to upgrade the property so that you make the most use of the funds and not over or under rehab it based on that the specific market this property is in. The value you get from doing a kitchen or bath upgrade varies from market to market and even within those sub markets there are differences. So having a good mentor or a good agent who understands how these most recent sales (comparables) can affect your appraisal value is important. The last thing you'd probably want to do is spend $40,000 in rehab but only get $25,000 in value on the appraisal at today's current comps. Then again sometimes you need to rehab first because the property may not even be in lendable shape or condition. I dont know because from what you wrote I know very little about this property and you had provided a very large value range 373k to 500's thats huge discrepancy.

The other question you asked was a legal question regarding  protection between the tenant and their work they promised as "consideration," or value for the rent. You may want an attorney to draft the lease with specific language as to what is considered value to value and what ramifications you might have in the event the tenant who is posing as the "tenant," and the "contractor," in this case does not perform exactly to your liking. Sometimes this may be one document or a lease and a separate contractor agreement. This is not legal advice so I'd advise you go talk to an attorney about it usually they will offer the first 30 mins or an hour free to start the relationship.

Hope that helps.

[Kaitlyn Masai]

@Jerry Padilla What I meant is there is only about 7k paid off on the loan. Oh ok, I think I understand what you're saying. The equity isn't just the money paid on the house; it is also the difference between the loan amount and what it is worth. So if we rehab the house and it's worth over $412.5k then we would be eligible to refinance. Should we hire an appraiser before rehabbing? 

[Kaitlyn Masai]

@Albert Bui

Hi Albert, thanks for the feedback. I meant that there is only $7k paid off on the loan. We don't have a rehab budget yet because we are still trying to decide how much work we should do on the house. It makes sense what you said about not spending too much on a rehab that is not going to add much value. 

There is for sure some work that needs to be done to make it rentable. We need to put in a new toilet, new floor, take out a broken built-in pond in the backyard, and some other minor cosmetic things. We could put a lot more work in such as adding a kitchen to the back room to turn it into a duplex. 

I got my comps from online sites, which is the reason why the range is so big. It seems generally to be $450k but I don't how reliable online sites are (like Zillow, realator.com, and redfin). It sounds like it would be better to get a real estate agent to give us better comps and help determine how much to spend on the rehab. Thanks for the advice about getting an attorney. That is probably a good idea since we are having the future tenant also do work for us. 

[Albert Bui]

Originally posted by @Kaitlyn Masai:

@Albert Bui

Hi Albert, thanks for the feedback. I meant that there is only $7k paid off on the loan. We don't have a rehab budget yet because we are still trying to decide how much work we should do on the house. It makes sense what you said about not spending too much on a rehab that is not going to add much value. 

There is for sure some work that needs to be done to make it rentable. We need to put in a new toilet, new floor, take out a broken built-in pond in the backyard, and some other minor cosmetic things. We could put a lot more work in such as adding a kitchen to the back room to turn it into a duplex. 

I got my comps from online sites, which is the reason why the range is so big. It seems generally to be $450k but I don't how reliable online sites are (like Zillow, realator.com, and redfin). It sounds like it would be better to get a real estate agent to give us better comps and help determine how much to spend on the rehab. Thanks for the advice about getting an attorney. That is probably a good idea since we are having the future tenant also do work for us. 

 HI Kaitlyn,

I wouldn't recommend using the zestimate or estimates from these websites. I do however use these sites just to view the actual sold properties then I do my own adjustments for each property to arrive at my value. Then again I've seen hundreds of appraisals so I have a better idea of how appraisers adjust and what appraisers adjust for to arrive at a value. This doesnt mean I even know how the value will turn out because each appraiser is different but we can only do the best we can.

The best bet is to use the actual sold properties within 1/4, 1/2, or 1 mile, that have sold within the last 3-6 months, are of the same title (SFr, condo, PUD, town home, duplex, fourplex, etc), lot size, and amenties.

The value is only of each upgrade  can only be determined by what the sales comps are available. So what I mean is for instance if a house sold with no HVAC system and one that did sell with HVAC/central air sold for 8,000 more that means most likely the appraiser will value the HVAC at 8,000. This doesnt mean it is prudent for you to install a HVAC because it might cost 15-20k to do so, but then again you have to sell the house so you have to weigh your pro's and con's on what work you do and dont do based on how the market judge's the "value," of each upgrade. Some markets or sub markets require a HVAC to even be marketable so thats what i mean by pro's and con's. 

Some neighborhoods you can get away with painting the existing cabinets and installing new hardware while in some nicer neighborhoods you wont even get traffic if you dont have a farmhouse sink, with 3 CM stone instead of the cheaper 2CM stone edge, and custom cabinets, etc as an example. 

Its important to watch new sales that go from asking to pending status and from pending status to sold status or back up because it gives you a good idea at whats coming down the pipeline and how these new comps will stack up against your property and what it takes to sell a property in a specific sub market. If a new comp comes out with HVAC worth 15k now HVAC has gone from 8k to 15k so its very situational and dependent on what comps can be documented at any specific time.