Finance Home Remodeling

[rjsob58]

We have a home remodeling project that we've been putting off for a while. It will be somewhere in the $35-$45K range. I am trying to decide whether to take a loan against my 401K, get a home equity loan or use my liquid reserves (saving acct & stocks) to cover most of it with one of the loan options to take care of the balance. I can probably cover $25K directly, but that would pretty much wipe out my emergency funds, so I don't think that is the right move. The 401K loan would be at 3.25%, while a home equity would be somewhere in the 5-6% range. Based on my crude calculations, my 401K returns over the last 3 yrs is 17.18% and over the last 5 years it is 9.19%.

I guess my main question is should I do a home equity loan or a loan against my 401k?

If I am missing any relevant info, just let me know. My job is very stable/secure so I don't see having to repay any outstanding 401k loan due to loss/change of employment. But I am 55 and have my eye on semi-retirement in about 6 years.

[john94549]

Mystified by that rate on the HELOC. We're paying prime minus 0.2% (3.05%) on ours. Have you shopped around?

Old HELOCs had rate floors in the rate range you mentioned, but our bank eliminated them some time ago.

[rjsob58]

Haven't really shopped it as my tendency is to go the 401k route. So if I get a 3-4% on the HELOC, you think that's the better option than the 401k loan?

[Aptenodytes]

I would deplete the emergency fund first. Your job is secure, and you can borrow against the 401-K if you really run into an emergency before you have time to replenish.

Something doesn't compute with your liquid reserves -- you say some of them are in stocks. Stocks aren't liquid (or shouldn't be treated that way).

If you are then only about $10,000 short, I would consider funding that out of foregone retirement contributions unless doing so would make you miss out on a match. I wouldn't pay 5% interest.

What's your mortgage rate? If you are a candidate for a refinance anyway you could cover the shortfall with a cash-out refinance.

[rjsob58]

My mortgage rate is 3.875. I would sell my stocks (non retirement account) and since I am planning to do this within the next few weeks, I am using their current value along with savings.

I've never been without a liquid (cash/savings) emergency fund. Rationally I could get the 401k loan in an emergency, but it just makes me uncomfortable not to have a savings account.

[drew1976]

We're doing a 25K remodel which is approximately the size of our emergency fund.

Found one of our credit cards had 0% for 18 months with a 1% fee (PenFed). Decided to do this just because it mentally forces us to be aggressive about paying that off (whereas replenishing emergency funds might get put on the back burner). We always have some Roth IRAs that are over 5 yrs where I could pull contributions in a true emergency.

[jsl11]

Do you have to do the entire 35k - 45k project all at once? If not, an alternative would be to do just part of it so that you do not excessively deplete your resources. Then, you will have the time to save up some additional money to do the remainder of the project.

Jeff

[Default User BR]

The PenFed 5-year fixed-rate home equity loan is still reasonably priced at 2.49%.


Brian

[nydad]

The 401K loan would be at 3.25%, while a home equity would be somewhere in the 5-6% range.

IMHO it doesn't make sense to compare interest rates like this - in a 401k loan (at least, mine works this way), you pay interest back to yourself. So your 401k is actually growing at that rate - instead of paying that money to a bank. It does mean that money is out of the market, and there is the balloon issue, etc - but they're not apples to apples.

[rjsob58]

The 401K loan would be at 3.25%, while a home equity would be somewhere in the 5-6% range.

IMHO it doesn't make sense to compare interest rates like this - in a 401k loan (at least, mine works this way), you pay interest back to yourself. So your 401k is actually growing at that rate - instead of paying that money to a bank. It does mean that money is out of the market, and there is the balloon issue, etc - but they're not apples to apples.

I agree completely, which is why I calculated & included my return %'s on the 401k. So my 5 year return was 9.19%, which means taking a loan against my 401k reduces my return by about 6%.

Option A) a $35K, 5 year 401k loan costs me 6% of "lost" retirement growth: $5,998

Option B) Assume a HELOC at 3.25%. Total interest paid: $2,968.

And taking the HELOC, doesn't take away from my contributions or growth of the 401K. Before I started looking at that math, I always "assumed" the 401k loan was a better option, since you are paying yourself interest instead of paying someone else. But the more I look at it, the more I think a HELOC is more "retirement friendly". I'm using some fairly simple math/loan calculators to come up with the costs.

I'm looking for the flaw(s) in my logic here. I'm hoping the collective Boglehead wisdom will point that flaw (or flaws) out.

[Aptenodytes]

You are asking people to play devil's advocate against your plan. Well, your plan doesn't seem that bad, but here goes:

1) There's the HELOC interest to pay, circa $3k.
2) There's the hassle factor of having to apply for the HELOC
3) You are overly concrete with respect to expecting 9% return in your 401-K. Even if that's what you earned the last 5 years, that's just not a sound way to estimate the return over the next year. You could be double digits positive or negative quite easily. You are making too much of that comparison, I think, with respect to a short-term loan.
4) You are being overly emotional about the emergency fund. That's free money waiting to be used (because interest rates are so low), and you are a good candidate for using it, with high job security and significant positive equity in your home (if an emergency happens you have good options).
5) You don't say anything about your savings rate -- how much new money goes into the portfolio each month? If it is reasonably high, why not deplete most of the emergency fund and make up the difference with respect to remodeling costs by diverting savings into the remodeling project for a few months. You would lose the portfolio return on the new money, but in the big picture that's not a big deal. You'd avoid $3K in interest. And you'd avoid having to apply for a loan.
6) As someone already pointed out, another attractive option is to do a large credit card balance transfer to one of the promotional 0% interest schemes. That, in combination with some emergency fund draw-down, is probably the most rational approach.

To my mind, those are the alternatives to consider,but as I said your plan isn't all that bad. Bottom line -- you can bring the net cost from $3K to virtually zero with just a little creativity, so why not try.

[johnep]

My current HELOC rate is 2.75% (-.50% from prime). If you want to have a HELOC for this or other future needs, you should be able to get a much better rate than 5 or 6%. Also, there is no hassle with mine. I have a checkbook for the HELOC and only have to write a check or transfer funds electronically into my checking account. It is easy to borrow the money but much harder to pay it back.

Keep in mind that a HELOC is tax deductible assuming you itemize. So the net interest rate you pay is interest rate minus your marginall tax rate.

IMO, the HELOC is better way to go, but you need to be comfortable with whatever approach you choose.

[rjsob58]

Thanks. I am asking for people to play devil's advocate, that's why I'm here. And all your points are valid. As for new money going in I contribute the max allowed plus the extra contribution allowed for "catch up". There are lots of simplifications and assumptions in my plan. I need to get comfortable with using my emergency fund as I do have alternatives available if the need actually arose.

Maybe I can get comfortable with using the credit card option as part of the plan. But I haven't rolled over a credit card balance in over 10 years, so I'd need to research/plan that out in detail to make sure it was completely paid off before any interest kicks in.

[STC]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

[gt4715b]

You're modelling the 401k opportunity cost wrong or at least there's another way to do it. If you take the loan from the bond portion of your portfolio, meaning that the stock/bond ratio in your 401k increases throughout the life of the loan, then the expected return should only be that of total bond which is roughly in the 3-4% range.

[Outer Marker]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

+1. If you're six years out from retirement and can't comfortably afford this with room to spare, I would think hard about a $45,000 remodeling. Streamline expenses and work on building up retirement savings.

[rjsob58]

You're modelling the 401k opportunity cost wrong or at least there's another way to do it. If you take the loan from the bond portion of your portfolio, meaning that the stock/bond ratio in your 401k increases throughout the life of the loan, then the expected return should only be that of total bond which is roughly in the 3-4% range.

Although you can't take the loan against a specific portion of the portfolio, redistributing at the same time would accomplish the same thing. Never thought of that. Thanks

[rjsob58]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

+1. If you're six years out from retirement and can't comfortably afford this with room to spare, I would think hard about a $45,000 remodeling. Streamline expenses and work on building up retirement savings.

There are actually more facts that support your recommendation (e.g. twin 12 yr olds - so 6 more years till college), but I haven't been looking at this as do or don't do decision. And in our area (DC Metro), the remodel is an investment in one of my larger assets.

[ThatGuy]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

That's been outmoded since at least 1407 when Banco di San Giorgio was established, but possibly as early as 2000 BC with grain loans.

The same stuff has been going on forever, and it's ridiculous to impose your own morality as a rose colored hue on top of 'old' values.

[STC]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

That's been outmoded since at least 1407 when Banco di San Giorgio was established, but possibly as early as 2000 BC with grain loans.

The same stuff has been going on forever, and it's ridiculous to impose your own morality as a rose colored hue on top of 'old' values.

I see, so paying interest on consumption items is the "new" values... Good luck with that, and thank you for the cash flows into my bond funds (which own instruments from lines of credit and asset backed loans). I will be sure to spend your money well.

[STC]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

+1. If you're six years out from retirement and can't comfortably afford this with room to spare, I would think hard about a $45,000 remodeling. Streamline expenses and work on building up retirement savings.

There are actually more facts that support your recommendation (e.g. twin 12 yr olds - so 6 more years till college), but I haven't been looking at this as do or don't do decision. And in our area (DC Metro), the remodel is an investment in one of my larger assets.

Repeat after me:

"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."
"A home is not an asset, it is a liability masquerading as an asset."

You have to live somewhere. Therefor a home is a consumption item, and home ownership is a way to front-load the lifetime costs of that consumption item. This is why MOST here (at least in the more advanced forums on Bogleheads) do not consider their home to be an investment. It's a pre-payment.

On top of that, please understand that remodels will typically get you between 50-80% of their cost in appreciation. So if you spend $40k, expect your home value to go up by $25k - $30k. Add an additional $4k or so in finance charges and you are spending $44k to get back $30k.

Your choice of course. But with 2 kids headed to college, and a small emergency fund, if you dont have a massive retirement portfolio... this is looking pretty sketchy in my book.

[rjsob58]

A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.

Ok, I'll repeat it daily as I'm here to learn. Straying slightly off topic: the home is not an asset, but isn't the equity an asset? It is part of my net worth, the majority of which is in retirement - 80% in 401/IRA. I wouldn't classify it as massive, but substantial.

My original question was how to pay or finance the remodel and I've got some good advice and options I hadn't thought of. I know you don't make these kind of decisions (whether to remodel or not), in a vacuum, so the extra advice and thoughts are welcome.

[DiscoBunny1979]

What ever became of that school of thought: "if you can't pay cash for it, you can't afford it."?

+1. If you're six years out from retirement and can't comfortably afford this with room to spare, I would think hard about a $45,000 remodeling. Streamline expenses and work on building up retirement savings.

------------------------

the other way to think about it is . . . How much is the house valued at today (appraisal value) versus other like homes in the neighborhood. If for instance, if you have purchased a house for $300K in a neighborhood that has the average house selling for $400K, then spending $45K on improvements doesn't sound unreasonable if it's to match a standard of what's expected in the neighborhood. However, if you purchased a house for $300K in a neighborhood that has the average house selling for $300K, then putting $45K into the house will not necessarily see a dime back, other than people saying it certainly looks nice in there. The OP has to determine if the money putting in really is just for the OP's enjoyment rather than getting it back later on. For instance, you can spend $$$ on granite counters and great looking kitchen cabinets. . .but guaranteed folks will come through saying they hate the color of the granite or they'd prefer different cabinet choices. It's all a matter of personal taste. Don't expect money back on big ticket items......and in 10 years anything you do will need replacing anyway due to wear and tear or being outdated - again.

[STC]

A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.

Ok, I'll repeat it daily as I'm here to learn. Straying slightly off topic: the home is not an asset, but isn't the equity an asset? It is part of my net worth, the majority of which is in retirement - 80% in 401/IRA. I wouldn't classify it as massive, but substantial.

My original question was how to pay or finance the remodel and I've got some good advice and options I hadn't thought of. I know you don't make these kind of decisions (whether to remodel or not), in a vacuum, so the extra advice and thoughts are welcome.

It all depends on how you look at it. Having shelter is a basic human need, and therefor shelter is a consumption item that needs to be paid for. You have two generic options when paying for this consumption of space:

1: Pay for the service (i.e. rental)
2: Pay for the asset (i.e. purchase)

In both cases you are paying to consume space over time. The fact that you have to consume space over time makes either option of paying for it a liability. Only excess space that you will not consume (rental property, or rental of a room in your house) can be considered an investment. With me so far?

Paying for the service (i.e. rental) is straight forward. You pay X and receive the space you need for the time period you need it. X changes over time. I don't think anyone would argue that this is a liability.

Paying for the asset (i.e. purchase) is not straight forward. You pay X and receive the space you need for the time period you need it. You also pay Y and pay down future consumption in accordance with your mortgage schedule. In other words, you pay a premium so that in 30 years the cost of consuming space over time is greatly reduced. But that isn't the whole story either. You also have to consider opportunity costs. As you build more equity in your home, that equity isn't being applied as an investment elsewhere. It is being applied to maintain the consumption of space over time. When you get to owning your home outright, that equity covers the vast majority of your housing needs (with the exception of maintenance, taxes, utilities, etc.). But what happens when you want to apply that equity elsewhere? You could (a) downsize, and reduce the cost of consuming space over time, or (b) move to a Pay for the service model and take your pre-payment of housing consumption (equity) and apply it elsewhere.

I hope I am doing a good job explaining this...

Bringing it full circle. I view this home remodel as an increase in housing consumption costs, which I would classify as an increased liability. Then I would make the go/no-go decision based upon my ability to increase my housing consumption costs in the context of my overall financial plan, and the joy that increasing my housing consumption costs would bring to myself and my family.

Some more eloquent then I:
http://online.wsj.com/article/SB1000142 ... 41888.html
http://genxfinance.com/your-home-is-not ... -like-one/
http://boss.blogs.nytimes.com/2009/08/1 ... nvestment/
http://finance.yahoo.com/news/pf_article_102603.html

[Outer Marker]

There are actually more facts that support your recommendation (e.g. twin 12 yr olds - so 6 more years till college), but I haven't been looking at this as do or don't do decision. And in our area (DC Metro), the remodel is an investment in one of my larger assets.

These are important additional facts that should weigh heavily in the decision. With college costs on the horizon, thinking about early retirement, unless you have substantial other assets, or a generous pension , you may be stretching yourself too thin. I would rather have a paid off house in retirement than a new kitchen and a mortgage. On the other hand, maybe you would be willing to work longer to pay for the extras ... its all a matter of personal choice . . . but there are unavoidable trade-offs that must be made.

As things would have it, I am going to be selling an inherited property in metro DC next month. I plan to spend about $3,000 to patch and paint, and do a bit of landscaping before putting it on the market. If you were going to sell your property next month, how much of the $45,000 would you be willing to spend to get a fair price? Anything over that is consumption.

[rjsob58]

STC: you explained it well. I understand the concept and it makes perfect sense. I have never looked at it that way, but then there are a number of things that I'm trying to get up to speed on. I've done pretty good; no debt other than the mortgage, putting the max away for retirement. But I could have done much better if I had found this site & philosophy earlier in life.

The remodel is an increase in consumption. I would be happy with new cabinets, a new fridge & a new floor, the last 2 I can do myself. But this is something my wife has been talking about for more than a few years. Hard to put a price on that. So its the intangibles that tip the scale for a go vs. no go.

I want to retire early, but its not a hard goal. And it will probably be semi-retirement to start. The college stuff will definitely tell the tale. That & my wife going back to work.

OuterMarker: Spending 45k to sell wouldn't bring 45k in price. But it is a good market. Based on the equity in our house and costs at potential "retirement locations", I'm fairly confident we can purchase a place outright. But then I know that can change. The remodel won't really change that.

[MoneyBagsRx]

I'm not qualified at all to comment on finances. BUT, with regards to the home remodeling, is there any way to reduce the costs by doing some of the work yourself? Or even find a handyman to do some portions for a smaller fee compared to a general contractor?

I mention this because my wife and I wanted a new kitchen floor. We had the job quoted to about $15,000. We said "no way!" and with some preparation and a whole lot of YouTube, we managed to do the job ourselves for $2,000 in materials in 1 week. I mean, what a difference! And for the record, we have minimal skills with regards to this type of stuff.

So, for your situation, depending on what it is, try and find a way to shave off some of the costs. Can you buy the materials yourself? Can you do the painting yourself? Can you do the gutting yourself?

[lwfitzge]

A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.
A home is not an asset, it is a liability masquerading as an asset.

Ok, I'll repeat it daily as I'm here to learn. Straying slightly off topic: the home is not an asset, but isn't the equity an asset? It is part of my net worth, the majority of which is in retirement - 80% in 401/IRA. I wouldn't classify it as massive, but substantial.

My original question was how to pay or finance the remodel and I've got some good advice and options I hadn't thought of. I know you don't make these kind of decisions (whether to remodel or not), in a vacuum, so the extra advice and thoughts are welcome.

It all depends on how you look at it. Having shelter is a basic human need, and therefor shelter is a consumption item that needs to be paid for. You have two generic options when paying for this consumption of space:

1: Pay for the service (i.e. rental)
2: Pay for the asset (i.e. purchase)

In both cases you are paying to consume space over time. The fact that you have to consume space over time makes either option of paying for it a liability. Only excess space that you will not consume (rental property, or rental of a room in your house) can be considered an investment. With me so far?

Paying for the service (i.e. rental) is straight forward. You pay X and receive the space you need for the time period you need it. X changes over time. I don't think anyone would argue that this is a liability.

Paying for the asset (i.e. purchase) is not straight forward. You pay X and receive the space you need for the time period you need it. You also pay Y and pay down future consumption in accordance with your mortgage schedule. In other words, you pay a premium so that in 30 years the cost of consuming space over time is greatly reduced. But that isn't the whole story either. You also have to consider opportunity costs. As you build more equity in your home, that equity isn't being applied as an investment elsewhere. It is being applied to maintain the consumption of space over time. When you get to owning your home outright, that equity covers the vast majority of your housing needs (with the exception of maintenance, taxes, utilities, etc.). But what happens when you want to apply that equity elsewhere? You could (a) downsize, and reduce the cost of consuming space over time, or (b) move to a Pay for the service model and take your pre-payment of housing consumption (equity) and apply it elsewhere.

I hope I am doing a good job explaining this...

Bringing it full circle. I view this home remodel as an increase in housing consumption costs, which I would classify as an increased liability. Then I would make the go/no-go decision based upon my ability to increase my housing consumption costs in the context of my overall financial plan, and the joy that increasing my housing consumption costs would bring to myself and my family.

Some more eloquent then I:
http://online.wsj.com/article/SB1000142 ... 41888.html
http://genxfinance.com/your-home-is-not ... -like-one/
http://boss.blogs.nytimes.com/2009/08/1 ... nvestment/
http://finance.yahoo.com/news/pf_article_102603.html

This is a fun debate..it's clear it's not a great example of an investment but asset is complicated. It's something that can change in value, be sold and converted to cash like other illiquid assets. If you went to a bank for a HELOC, I think the bank views the home as an asset as the collateral for a loan. I'm swayed that its not an asset in the sense that assets are expended to generate positive cash flow (create value) and for a majority of homeowners (not real estate investors), a home is mostly cash flow negative with a pile a monthly expenses.

[Outer Marker]

The remodel is an increase in consumption. I would be happy with new cabinets, a new fridge & a new floor, the last 2 I can do myself. But this is something my wife has been talking about for more than a few years. Hard to put a price on that. So its the intangibles that tip the scale for a go vs. no go.

I want to retire early, but its not a hard goal. And it will probably be semi-retirement to start. The college stuff will definitely tell the tale. That & my wife going back to work.

OuterMarker: Spending 45k to sell wouldn't bring 45k in price. But it is a good market. Based on the equity in our house and costs at potential "retirement locations", I'm fairly confident we can purchase a place outright. But then I know that can change. The remodel won't really change that.

You've got all the facts now and are thinking about it the right way. Nothing wrong with spending money on what makes you happy, but you've got to see it for what it is. I'm going to spend $3,000 to replace the awful builder grade bathroom countertops and mirrors in my 8 year old house. I want to, I can afford to, and I plan to be here a while. Makes sense for me, but it won't move the needle at the settlement table when I sell this place and move to the ski hills . . .

[STC]

The remodel is an increase in consumption. I would be happy with new cabinets, a new fridge & a new floor, the last 2 I can do myself. But this is something my wife has been talking about for more than a few years. Hard to put a price on that. So its the intangibles that tip the scale for a go vs. no go.

I want to retire early, but its not a hard goal. And it will probably be semi-retirement to start. The college stuff will definitely tell the tale. That & my wife going back to work.

OuterMarker: Spending 45k to sell wouldn't bring 45k in price. But it is a good market. Based on the equity in our house and costs at potential "retirement locations", I'm fairly confident we can purchase a place outright. But then I know that can change. The remodel won't really change that.

You've got all the facts now and are thinking about it the right way. Nothing wrong with spending money on what makes you happy, but you've got to see it for what it is. I'm going to spend $3,000 to replace the awful builder grade bathroom countertops and mirrors in my 8 year old house. I want to, I can afford to, and I plan to be here a while. Makes sense for me, but it won't move the needle at the settlement table when I sell this place and move to the ski hills . . .

Agreed. Thinking about it the right way. No rationalization. Your call from here. No wrong decision. Good luck.