Financing a renovation

We are (finally) getting close to starting our kitchen renovation/addition, which has turned out to be much more expensive than I ever imagined we would spend, as it includes quite a bit more than just the kitchen. 

It's hard not to keep questioning the sanity of spending this much money when we've already lived here for 20 years and can only hope to afford to continue living here for the next, say, 10 years, especially when so many people at our stage (our only kid is heading to college in the fall) are talking about leaving for greener (lower) pastures (taxes). But, we're pressing forward, and need to figure out the best way to pay for this hopefully wise investment - both in terms of our enjoyment and enhanced resale value when the time comes.

A few years ago, we set up a HELOC, but if we used it, it would cover only a fraction of the total renovation costs. We could theoretically apply for an increase, but it has an adjustable interest rate and rates are going up, so it doesn't seem like the best choice.

We actually have enough money in our non-retirement, non-college savings to cover the cost and still have a decent cushion left - assuming the market doesn't tank between now and the completion of our project - but our financial advisor seems to be steering us to consider a cash-out refi. I have mixed feelings about this for several reasons.

1. We have about 6 years left on our current mortgage, with a rate of 2.625%. I'd hate to restart that clock, at a necessarily higher rate, plus closing costs, with considerably higher monthly payments for a long time to come that would probably require us to liquidate some of our savings in any case to cover.
2. We are not spring chickens, and I don't like the idea of taking on so much debt when there is no guarantee of how our money remaining in the market will perform.
3. We will still have plenty of retirement savings invested in the market to take advantage of any gains to be had there.

What would you do?

Consider the conflict of interest of the financial advisor. If you take money out he/she makes less money. 

I would not get rid of your current mortgage given the low rate. 

Remember it is not an all one thing. You can use some savings and some heloc. 

Thanks, Gilgul, for the confirmation. Indeed, that point about the conflict of interest was not lost on me, and it's one of the issues I have in working with Merrill, but that's another story. Yes, I can definitely dip into the HELOC to pick up at least a decent chunk of the cost.

jasper,

A renovation for your comfort and enjoyment; sounds good to me. Doing it to increase the sale value; that's probably a losing proposition.

In any event:

Take a look at bankrate.com, and call the lender with the lowest APR.

The default settings at bankrate probably don't fit your circumstances, but it's worth a call.

Another alternative, look at the loan terms of your 401 (or similar) retirement account. The lovely bride tapped her 401, some years ago, and although the rate was higher than consumer market rates; the interest was paid back into the 401.

Hope all works out well.

TomR

if you pay cash out of your savings you won't get to deduct the interest paid on a loan, but that deduction would not offset the savings you would realize by not paying interest if you use your savings.  Since you say you can afford it without tapping retirement funds, I'd use cash.  

Agreed, Tom_R, that it wouldn't be worth all the time and effort we've already put in before construction has even begun, never mind the money, just for resale value. The intention really is to enjoy our home for ourselves and to make it more comfortable to have friends/family over, but I certainly hope that at least a portion of the money invested comes back to us when we do ultimately sell.

Interesting idea about borrowing against a 401K. Ultimately, it comes down to whether the interest on a loan will cost more than you would have earned on that invested money, which of course is hard to predict over a period of years. There is also the tax ramification of selling fund shares, though we've paid plenty of taxes on capital gains distributions over the years, so presumably our cost basis is reduced. I still lean towards using the savings rather than increasing our debt.

Borrowing from a 401K splits experts. Some love it, some hate it. I think it is ok but with two caviats. First some plans prevent new contributions while a loan is outstanding and in those cases it is definitely not a good thing to di. Second if you leave the company the loan needs to be repaid in full immediately or else the outstanding balance becomes a taxable distribution. 

if only staying 5-10 years, I'd think long and hard about an extensive renovation especially if it means cutting into a 401k or taking on massive debt. A homeowners loan is often around $30-50k so you must be talking about a HUGE, expensive renovation. I'd speak to realtors to understand if/how much it'll increase the home value. And you'll have to be very careful to select a design and lay out that won't be highly personal in style which may defeat the whole purpose of the renovation for enjoyment.

local RE market is so high right now, i think I'd speak with a realtor to see where you are without the new kitchen. 7 years from now who knows what will be. 

Personally, I'd use non college savings. It actually may help to have less in savings when it comes to financial aid for school anyway. 

What about borrowing from your 401(k)?   I think $50,000 is the limit, interest rates are low and you pay it back to yourself.   

Being a hopeless cheapskate, I'd do nothing if you're planning to move in 5 years. If it's more like 10, I guess that's a different story. Borrow as much as you can from the HELOC, pay cash for the rest. 

I would like to be educated here.  If Jasper can pay for this in cash without hurting retirement and still have cash left over, what is the advantage of borrowing against retirement or using a Heloc?

FilmCarp said:

I would like to be educated here.  If Jasper can pay for this in cash without hurting retirement and still have cash left over, what is the advantage of borrowing against retirement or using a Heloc?

It sounds (to me, at least) that the cash is invested in the market. That 10% anticipated return is more than you'll pay on the HELOC.

Also, a HELOC (as far as I understand) can be pulled by the bank if unused. In the even of a catastrophe, I'd rather have some cash and a piece of paper that says I owe the bank.

Ask his financial advisor.  Maybe it actually would hurt his retirement.

FilmCarp said:

I would like to be educated here.  If Jasper can pay for this in cash without hurting retirement and still have cash left over, what is the advantage of borrowing against retirement or using a Heloc?

FilmCarp said:

I would like to be educated here.  If Jasper can pay for this in cash without hurting retirement and still have cash left over, what is the advantage of borrowing against retirement or using a Heloc?

For the same reason you take a mortgage when interest rates are low -- even if you can buy a house all cash. Because money is cheap right now. Better to keep your cash in the market. The opportunity cost of paying cash is the returns you'll get in the stock market.

shh said:

 It actually may help to have less in savings when it comes to financial aid for school anyway. 

This is a common misconception. It is never, ever a good strategy to purposely spend down assets or make less income to get "better" financial aid. The math rarely works out.

shoshannah said:

FilmCarp said:

I would like to be educated here.  If Jasper can pay for this in cash without hurting retirement and still have cash left over, what is the advantage of borrowing against retirement or using a Heloc?

For the same reason you take a mortgage when interest rates are low -- even if you can buy a house all cash. Because money is cheap right now. Better to keep your cash in the market. The opportunity cost of paying cash is the returns you'll get in the stock market.

I see. So the assumption is that the savings are invested in a fairly aggressive way.

I am under the impression that kitchen renovations do actually pay for themselves. Not only that, a more desirable house sells more quickly.

The best way to cash out of that is to sell as quickly as possible, assuming you can cut expenses after you move. That's what we did. We moved out when our house was fully renovated. The sooner you start saving money, the more you have left over. Of course you know that, but think about how you can save after selling. Once you have a good idea about that, the financing options don't seem so complicated since you already have several good options to choose from.

I am in a similar situation as Jasper.  We are empty nesters (youngest just graduated from college but won't be moving home) and we want to stay in our home for at least another 5-10 years, maybe more, and we realize that we have deferred a number of projects that would really make the house nicer and add at least some resale value.  In fact, if we can figure out how to make the home somewhat "elder friendly", we might stay longer than that.  I do not want to make a decision to sell in 10 or 20 years and then find that I have to do many of those renovations in order to make it "ready to sell" but not have a chance to enjoy them.  We have paid off our mortgage, so even though Maplewood taxes are attrocious, our monthly housing costs aren't really so bad when we consider the alternatives.  It's the home maintenance and accessibility that will become onerous as time goes on.  (And we are not retired yet, so no moving "to the boonies" ... but I don't think we ever want to do that if we can avoid it.) 

We are working on identifying and prioritizing our desired updates and hope to start on it within the next year.  

A run down kitchen definitely turns off buyers. Many will not want to deal with a redo immediately. A very specialized look or overly expensive items will not bring a return. But a nice kitchen will help the value. And added space in the right places (say a bigger kitchen or a family room) also would bring a nice return. Maybe not 100% but enough given the enjoyment factor.

if you are staying 10 years or longer, I would renovate based on what you want, not based on some potential resale value.  10 years from now, your kitchen will be considered dated and you will not recapture the cost via the increased resale value.  Plus nobody has any idea what the market will be like when you want to sell. 

if anything the issues with NJ transit and the plans to completely renovate penn station and the tunnels could mean a very tough sales market till that work is completed.  

Kitchen renovations do not necessarily pay for themselves.   You have to  take into account the property value of the house, of the other houses in the neighborhood, and the physical attributes of the house itself.  Over improving a house and making it out of line with the others in the neighborhood makes you lose on resale usually.