for your remodeling plan
5. Pay from savings if you can manage it
If you have the luxury of a having substantial personal savings account, tapping that nest egg might (or might not) be a good way to cover the cost of your renovations. The deciding factor should be where you are keeping that money and how much interest it earns.
First, Ferrara says, consider
the cost of borrowing money.
"Say the cost is 8 percent,
and I am able to itemize and deduct the first
$100,000," he says. "My net cost,
if I am in the 25 percent bracket, is 6 percent.
What you need to then look at is, is my cash
earning me more than a net 6 percent?"
Assuming you have a sufficient emergency fund
and enough cash on hand to handle your monthly
expenses, Ferrara says paying cash can be
a good idea. "But, if you can earn more
than 6 percent after tax, investing and then
borrowing the money to cover your renovations
would be the obvious good thing to do,"
The reality of most borrowers
is that their cash is not earning 6 percent,
says Dan Fritschen, author of "Remodel
"When it comes down to
it, if you can pay out of savings, that is
usually the cheapest money you are going to
find," Fritschen says. "Borrowing
money always costs you something, and if you
are only earning 1 percent on your savings
account, it doesn't make sense to borrow it
at the much higher rate."
6. A hybrid savings-equity loan can be tricky but effective
If your savings are earning a healthy return, Ferrara says, there is a way to let that money continue to work while using it to finance a renovation. He does this by setting his clients up with an investment account earning an interest rate higher than the loan. He then sets up an automatic draft from that investment account to make the loan payments. The savings pays off the loan and has the potential of earning a surplus for the borrower.
"This method sounds neat,
but the drawback is that you are subject to
the market," Ferrara says. "You
have to remember, with any investment you
are taking a risk." The danger is a loss
on your investment portfolio and a loan that
still needs to be paid off. "But I would
like to think that over 10 years your gains
and losses would average out and you would
do OK," Ferrara says.