Dear Dr. Don,
I have a question about whether to use a home equity loan to finance a home improvement project.

My husband and I want to do some landscaping projects in our backyard this coming summer. We budgeted $5,000 for these projects and will prioritize what we can do once we start getting estimates. We currently have about three months of emergency funds and have separately saved about half of the $2,500.

My husband was thinking of getting a home equity loan (because interest is tax-deductible) for the project and adding that separately saved money into the emergency fund to build it up for real emergencies. I would rather use the saved money instead of taking out another loan. Even though interest on the loan is tax-deductible, it’s still a loan.

We have great credit scores (low 800s) and our mortgage is currently 77 percent of our house value. I know a third option is to wait. Putting aside the third option for now, is it better to take out an equity loan or use the saved money for the projects?
— Ngan Nasturtiums

Dear Ngan,
Even though the closing costs on a home equity loan tend to be quite low, paying just $500 in closing costs on a $5,000 loan dings you for 10 percent before you even consider the annual interest expense on the loan.

As you say, even though the mortgage interest expense is tax-deductible, it’s still a loan. You can estimate the after-tax interest rate on the loan by using Bankrate’s mortgage tax-deduction calculator.

I don’t like to see people dip into their emergency funds for nonemergency expenses. You’ve got half the money saved for the project already. Keep building your savings and see where you’re at by spring. If you have a reasonable interest rate on your credit card (less than 15 percent) and expect to be able to pay off the balance in less than a year, I’d suggest using your credit card to finance the balance. That’s especially true if the card provider is offering special terms.

I used Bankrate’s “What will it take to pay off my credit card?” calculator and assumed a 15 percent interest rate. At that rate, assuming you could afford monthly payments of $225.65 per month over 12 months, you would spend $207.80 in interest paying off an initial balance of $2,500. That trumps paying $500 in closing costs plus interest on a home equity loan.

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