This article appeared in the Spring 2021 issue of This Old House Magazine.
Has more time at home given you ambitions for upgrading your surroundings? Maybe you’re yearning for a “sanity shed” where you can take undisturbed work calls in the backyard. Or you have visions of a family room refresh that also creates space for a family study hall.
Ways to Pay for a Home Remodel
Once you’ve talked to contractors and worked up a remodeling budget—with room for unexpected expenses, of course—the next step is finding the funds. Do you dip into savings or borrow the money?
With mortgage rates hitting historic lows, tapping your home equity seems like a good idea, even if recent changes in the tax law make it less likely that you can deduct the interest. A soaring stock market may have left you with a plump portfolio to draw from, while interest rate cuts mean the cash you have sitting in the bank isn’t doing much of anything, making that a tempting target.
All the while, your credit card company is dangling new ways to pay for major expenses. Here’s how to sort out your options and do what’s best for your financial well-being.
Start with the Money You’ve Saved
With interest rates so low, the cash you have sitting in the bank is earning little to nothing. You aren’t missing out on much by using that money for a renovation—and you won’t have to incur any borrowing costs.
“Obviously, the best way to get funds is to tap your taxable money,” says Allan Roth, a certified financial planner at Wealth Logic in Colorado Springs, CO. If you’re nervous about spending down a cash cushion, do an inventory of your emergency reserves, which can include an open home equity line of credit (HELOC) or investment accounts outside of your retirement plans.
“How much of an emergency fund you need is an individual decision,” adds Roth. “But you need to be able to sleep well at night.”
Next, Tap the Value of Your Home
See if your home can help pay for the work. “It’s an opportune time to borrow,” says Greg McBride, chief financial analyst at Bankrate.com. “The rise in home prices has left homeowners with more equity, while mortgage rates have declined to record lows.”
It used to be that borrowing against your home would also earn you a nice tax break. But since the 2017 tax overhaul, that’s less likely. For one thing, most filers no longer itemize deductions. And home-loan interest is deductible only if it’s also used to buy, build, or substantially improve your home.
Still, today’s low rates make home borrowing very affordable. Two options to consider:
- Cash-Out Refinance: You’ll pay the lowest interest rate by refinancing your entire mortgage into a larger loan and taking out cash for your renovation. The average rate on a 30-year mortgage has been hovering around 3 percent for the past year. “A cash-out refi only makes sense when you’re looking to refi anyway,” says McBride. “But given these unprecedented low rates, everyone should consider refinancing.”
- Home Equity Line of Credit (HELOC): There are good reasons to skip a cash-out refi. Maybe you’ve already refinanced into a low rate. Or you’re deep into repaying your mortgage. By refinancing, notes Keith Gumbinger, vice president at the mortgage information site HSH.com, “you’re restarting the clock, and could pay more interest over time.” With a HELOC, you’ll pay more in interest—a variable rate that’s recently averaged 5 to 6 percent—but you’ll have more flexibility to withdraw and repay the money on your own schedule.
Be Cautious About Using Your Retirement Funds
Withdrawing money from your retirement accounts can trigger a big tax bill. You’ll pay income tax on withdrawals from a traditional IRA or 401(k) plan, plus an early withdrawal penalty if you’re under age 59½. That could turn a $30,000 withdrawal into less than $20,000, assuming a 32 percent federal tax bracket and a 10 percent penalty.
With a Roth IRA, which is funded with after-tax dollars, you can withdraw your contributions at any time without owing taxes or incurring a penalty. Still, spending long-term savings now reduces how much money you’ll have for retirement later.
One workaround is to borrow from the account. Many workplace retirement plans allow you to take out a loan of up to $50,000 (or 50 percent of your assets, whichever is less) against 401(k) savings. You’ll owe interest, but no taxes or penalties provided you pay the money back.
However, if you leave your job with an outstanding 401(k) loan, you’ll have to repay it soon afterward.
Know the Risks of Borrowing Against Your Investments
Your stocks and bonds can be another source of funds, but you’ll owe taxes if you sell at a profit outside of a retirement account. An alternative is to borrow against the value of your portfolio, what’s known as a margin loan.
Rates, which are usually variable, vary widely: anywhere from 3 to 8 percent, depending in part on the size of your loan. However, margin loans are highly risky. If the value of the stocks you’re borrowing against falls sharply, you might have to put money back in your account quickly or sell some of your investments to raise cash.
What About Putting it on Credit?
If you’re financing a large-scale renovation, credit-card interest rates will be far higher than what you’d pay on a mortgage or other home loan right now. You might be tempted to take advantage of a 0 percent introductory rate or balance transfer offer, but tougher credit standards due to the economic downturn have made those deals harder to find (you can search for them on Bankrate.com).
Plus, “you’re playing with fire a little bit,” says McBride. With a 0 percent balance transfer deal, the potential pitfall is that the rate may not apply to new expenses. If you put renovation costs on a card with a 0 percent introductory rate, you have to be disciplined about spending and paying off the balance before the interest rate resets higher.
Just buying a big-ticket item, like a pro-style range or HVAC equipment? Credit card issuers have been rolling out flexible payment plans to existing cardholders, including American Express’s Pay It Plan It option, Chase’s My Chase Plan, and Citibank’s Citi Flex Loans. Programs like these offer fixed monthly payments, typically three to 18 months.
You may be charged a monthly fee or fixed rate rather than interest that can fluctuate. The appeal is that you don’t have to go through the hassle of applying for a loan, but fees are still an added expense. To be safe, make sure you’ll be able to pay off the purchase without missing a payment, or you could face even higher costs.
