 Paying
for a swimming pool
|
 Dear
Dr. Don,
I am undertaking the addition of
a swimming pool to my yard. What is the smart way to finance this project, or
should I just pay cash if I have it? Please consider tax advantages for
home equity loans, etc. I want to use such a substantial amount of money in the
right way.
Fran Finance  Dear
Fran,
The decision
whether to borrow or use savings to pay for the pool depends on what the loan
will cost you on an after-tax basis and what your investments could be earning
if you kept them working. Too many people focus only on the tax advantages of
using home equity debt. While it's true that the interest expense will generate
tax savings for most homeowners, you still have to consider the after-tax cost
of the loan.
As a simple example, if the interest rate on the home equity loan
is 6 percent and your marginal tax rate is 33 1/3 percent, then your effective
interest rate is 4 percent because the interest expense reduces your taxable income
by an amount equal to the tax rate times the interest expense. Calculating
the after-tax cost of debt is made more complicated when you have to also consider
state and local income taxes, but multiplying the interest rate on the home equity
loan by one minus the combined marginal tax rates provides a reasonable estimate
of the effective interest rate in states where you can use the deduction in calculating
your state and local taxes. If you expect to earn more on your
investments after tax than the after-tax cost of debt on your home equity loan,
you should keep the money invested. The financial dilemma is that your stock market
investments won't provide you with a guaranteed return while the interest savings
is a sure thing. But, if the money is earning 1 percent after-tax in a money market
account, you will realize a 3-percent savings, in my example, by paying cash for
the pool. Don't break into your emergency fund to pay for
the pool. Regardless of how hot it is outside, buying a pool is not a financial
emergency. Most financial advisers recommend that you keep three to six months
worth of living expenses in liquid investments, meaning investments that you can
access quickly without paying a financial penalty to do so. | 
