When determining the right approach to plan for home improvement projects, I like to make sure I’m correctly assessing the cost of money. The two ways to pay for a project is to pay now (cash), or pay later (some variety of financing). Today I’m going to explore how two different perspectives come in to play when deciding on how to pay for a big project.
Cold, Hard Cash
Let’s start with the straightforward cash option. I decide to pay someone to renovate my kitchen, get everything planned out, and the quote comes in at $75,000. Realistically, it would take a family YEARS to save $75,000. Most would automatically be intimidated trying to find that amount in their budget. Would this be a good choice to try and save and pay in cash? Probably not, but if you can — that’s great! Go for it! The quote is usually only good for a few months at the most, so the cost of the quote will probably increase. However, if paying in cash is something you are able to do, most contractors will drop the price a few percentage points (3-5%).
For my example, I’m choosing to save. Where do I put the money? Standard savings account? HYSA? How many years does it take me to save $75k? At most the money will be earning 1% in a HYSA (right now rates are closer to .5%), current inflation in the US is around 2.25%. This means the money I’m saving is worth less money every year, to the tune of ~1.75% every year. If I’m able to save $10,000 per year, I would lose almost $5000 to inflation. The point is, paying cash could be a roadblock from being able to ever begin a project.
Financing
Financing can be one of three options — contractor financing (usually through a third party), Home Equity Line of Credit (HELOC), or a personal loan. Any of these three options are fine, but I would do the research, rate shop, and make sure all fees and ramifications are included in the assessment. As a general rule, personal loan rates will be higher than HELOC rates. Sometimes contractor financing has a special rate, but contractor financing is not always available. To fund the kitchen via financing, I am going to select a HELOC as my method of financing.
A HELOC can be opened at any time and usually has a grace period of several years to make a draw on the credit line. By choosing a HELOC, I will have up to 90% of the value of my house available in credit to use to make home improvements. The rates are currently around 4% and I can keep my investments in the stock market making at least 10% ROI. This approach is a bigger picture approach and has a positive net gain of roughly 6%. A word of caution — this approach will only work if you can maintain a balanced budget that will be able to absorb an additional monthly payment when it comes time to repay the loan.