$200K - home addition or pay home loan?

8 Replies | San Jose, California

We have the ability to pay $200K on our existing loan which is at 4%.

Instead I am wondering if I should invest in an addition (approx 600 sq feet), 1 master bedroom, 1 bath & space for office. Current home is ranch style, 2200 sq feet and we have the lot size to support this addition.

The addition will give us the ability to rent out a portion of the house (2 bedrooms + 1 bath) which could be rented for approx $2000 per month+utilities. This will not interfere with the main portion of the house.

The addition will also increase the property value by approx $500 per square feet.

$200K will not buy us another house in Bay Area, I am reluctant to go out of state and I don't want to invest in the stock market. So I think addition makes sense to me however not sure if I am missing anything?

Paying down your mortgage will only get you a 4% annual return. Adding the addition will give you a "paper" return of 150% (600 sq ft x $500 per sq ft added value = $300,000) which you'll only realize once you sell your home. Keep in mind that your property taxes will increase if you build an addition. Personally, I'd look to see if I could find a duplex or triplex to buy with and FHA loan that requires only 3.75% down. Here's a link to the maximum FHA loan values by county in California for 2, 3, and 4 unit buildings. http://www.fhahandbook.com/blog/california-loan-limits-2018/

Originally posted by @David Cruice :

Paying down your mortgage will only get you a 4% annual return. Adding the addition will give you a "paper" return of 150% (600 sq ft x $500 per sq ft added value = $300,000) which you'll only realize once you sell your home. Keep in mind that your property taxes will increase if you build an addition. Personally, I'd look to see if I could find a duplex or triplex to buy with and FHA loan that requires only 3.75% down. Here's a link to the maximum FHA loan values by county in California for 2, 3, and 4 unit buildings. http://www.fhahandbook.com/blog/california-loan-limits-2018/

 Thank you David!

Hi Pooja,

If your interested in building a addition, feel free to reach out anytime. I’ve built a few in the area feel free to reach out.

Thanks
Zab

You are right that $200k will get you nothing in the Bay Area. My vote is to do the addition. It yields you roughly 10% even after taking property tax and insurance into account. Use that cash flow to make extra payments towards your mortgage on the primary house. Also - since this is your primary home, you could refi all the way down to 3.5% and save some money there. Consult with the CPA to understand if ADU income is offset by depreciation of the ADU. If you have a lot of equity in the house, you could also use HELOC to fund the ADU construction. Lots of options!

Originally posted by @Pooja C. :

We have the ability to pay $200K on our existing loan which is at 4%.

Instead I am wondering if I should invest in an addition (approx 600 sq feet), 1 master bedroom, 1 bath & space for office. Current home is ranch style, 2200 sq feet and we have the lot size to support this addition.

The addition will give us the ability to rent out a portion of the house (2 bedrooms + 1 bath) which could be rented for approx $2000 per month+utilities. This will not interfere with the main portion of the house.

The addition will also increase the property value by approx $500 per square feet.

$200K will not buy us another house in Bay Area, I am reluctant to go out of state and I don't want to invest in the stock market. So I think addition makes sense to me however not sure if I am missing anything?

Paying off $200k will only have a 4% ROI, as others have said.

Building the addition will probably not add $200k in value to the home when it goes to sell. Less. GCs are too expensive in our area.

However, you will get that rental income. If you plan to hold onto it long-term, that could make sense. 

$200k is also 25% down on a 2-4 unit property, after closing costs just under $800k.

I think you've got some good advice here. While paying down principal can yield you 4%, once you make that payment, that's money you can no longer use should you want to. You lose control over it unless you refinance and pull the cash back out, but of course, that comes at a cost. Even if you expect to make only a 4% cash on cash return from the rental income generated by the expansion not including added value to the home, that's a no brainer since it's cash coming into your account that you can actually use and re-deploy to have it work for you vs having it trapped in the equity that you cannot have work for you.

Adding to this thread. Not all areas make sense to build an addition. It really depends on your neighborhood to make that call. You could consider building an ADU to rent out as $200k can get you about a 500 sq ft ADU.

@Pooja C. - we were in your shoes last year ... pay down our primary mortgage or buy property? We decided to buy 2 SFHs $620k each 2 bed/1bath house. The more real estate aka land the better. Then later you can go back and add to them. At least over time your property will appreciate over time. Now that we have 2 SFH rentals we are working on converting the garages into ADUs. We almost break even w the mortgage from the rent but we know that over time the ADU will bring in the big cash flow for us. If you have the space in your primary then I'd do it if you can't find another property to buy.