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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.

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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.'s corrections policy-- Posted: July 15, 2002
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