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Dr. Don Taylor, CFA, Bankrate.com advice columnistFinancing a remodeled kitchen

Dear Dr. Don,
My wife and I are looking into remodeling our kitchen. We figure that it will cost around $10,000 to $15,000. We have a combined annual income of about $100,000. We have $20,000 in liquid savings.

My question is; should we just pay for the remodel outright, or take a home equity loan for all or part of the amount needed. We are mostly debt free, just a $150,000 mortgage on a home worth $450,000 with a monthly payment of $1,685, and a car payment of $330 a month for the next 18 months. Our credit cards are paid off each month to a zero balance. Thanks for your advice.
-- Jim Judicious

Dear Jim,
If having only $5,000 in liquidity doesn't bother you because you have enough other investments in your portfolio that can be sold, if needed to raise cash, then the easy recommendation is to pay for the remodel out of your liquid funds. You can rebuild your liquidity over time versus making monthly payments on a home equity loan or home equity line of credit (HELOC).

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As I write this reply, the national average for home equity loans is 7.53 percent and the national average for a HELOC is 7.66 percent. Assuming you can use the mortgage interest deduction on your taxes, closing costs of $750, and a 15-year amortized loan, that puts your effective rate, ignoring state and local taxes, somewhere between 5.5 percent and 6.375 percent. Use the CCH calculator to come up with the effective rate using your marginal federal tax rate and applicable state and local taxes.

The point is, you'll be hard pressed to have your liquidity invested at an after-tax rate higher than the effective rate on a mortgage, so borrowing to finance the kitchen remodeling doesn't make sense if you have other assets that you can use in a financial emergency.

A HELOC is a nice backstop that will provide liquidity in a financial emergency if it's in place prior to when it's needed. Taking out a HELOC and paying it down over time would free up the credit line to use for emergencies or a car loan, or both later on. My assumption here is that you don't need a credit line for liquidity or a car loan any time soon, so there's no real need to finance the remodeling job.

Bankrate.com's corrections policy -- Posted: March 17, 2006
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$50K HELOC 4.51%
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