Ask the grumpies: Pay for renovation in cash or take out loans?

Ellie asks:

I am moving to take a new job and have been fortunate enough to be able to buy a house in New Town right off the bat. There is, however, some fairly significant work to do on said house, also right off the bat. I will have enough cash from the sale of my house in Current Town to cover the cost of this work, but am wondering if I should. Given what’s going on with interest rates, would you pay for renovation work in cash? Or take out a second mortgage/HELOC to cover reno expenses and invest the house proceeds? Once moving expenses work their way through the cash flow pipeline, I would be able to pay off a second mortgage pretty aggressively.

I feel like this should be a relatively simple opportunity cost calculation, but somehow it doesn’t feel as simple as it feels like it should. Secondary question: Is there any way to blame the Ongoing Unpleasantness for making this a harder decision that it ought to be?

Well, if you’re asking what we would do, we would pay in cash.  It’s possible you could open a HELOC in case of emergency and then just not use it unless there’s an emergency. But, we also left carpet in the childrens’ bathroom until our mortgage was mostly paid off (and #2 doesn’t even own a house), so we may be too risk averse.

In terms of what is optimal:  If this is just a short term cash-flow thing, then you won’t be wasting much time not being in the market and can put the moving expenses into it once they’re done.  Second mortgages are a hassle and sometimes you are not allowed to prepay them or you still have to pay for mortgage insurance even after you’ve hit 20% loan to value ratio (this will depend on the mortgage terms– some of them are pretty nasty).  HELOCs tend to have interest rates that are higher than your first mortgage and make the uncertain gains of the stock market less attractive compared to the certain losses of the HELOC.

If this were a longer term thing in terms of repayment, say, more than a year, you’d want to look at the bigger picture more carefully and it might be more worthwhile to take out some additional debt (probably the HELOC rather than the second mortgage just because the hassle factor is smaller, but intelligent people will disagree on this).  Mainly the margin I would be looking at would be an employer match for retirement.  If paying in cash for renovations means that your retirement savings isn’t going to happen, then I’d take a long hard look at that– what renovations need to actually happen, and what are interest rates on loans?  Getting an employer match will blast past most interest rates, even high ones.  Then after that you’ll have to think about whether you’ll remember to set up more retirement savings once you have money again– if not, then you might want to set that up and take out more loan just so you don’t lose out on retirement savings by not getting around to setting it up.

The Ongoing Unpleasantness makes long-term planning difficult for many people.  Uncertainty at large makes things difficult at small.

So:  tl:dr

If you’re going to have the money in a few months, pay in cash.
If it’s going to be longer, make sure you get your employer match for retirement and take a loan if you have to.
Then: think about hassle, interest rates, and how likely you are to set up retirement savings later.

Update with some numbers:

The total cost of the work will be in the neighborhood of $40,000. So a very decent chunk of change that could do a lot of things. Once the down payment on the new house is made, I should have about $59,000 left of the proceeds from selling my current house and I have $40,000 or so cash in savings. I don’t have any other debts that would be logical first priorities—student loans and car are paid off, and credit cards are paid in full every month. But there will be some decently expensive travel & transition costs in the immediate term, as well as some concerns about cash flow because the new job pays 9-month contracts over 9 months, without the option of distributing payments over 12 months. So there will be a couple of months between the last paycheck from my current position and the first paycheck from the new one.

It looks like the local credit union there is offering home equity loans at 4.75%.  [No numbers for a second mortgage.]

Investing options are… my Roth [IRA and] my TIAA-CREF [presumably a 403(b) through work].

One thing to remember is that you’re most likely not going to have to pay all of the renovation costs upfront.  So it is possible that some of the bills will not come due until after your reimbursements have come in, possibly after your paychecks have started (depending on how long things drag).  You won’t need to decide on the IRA until April.  It sounds like you will have enough leftover that you should be able to start your retirement savings via direct deduction from your paycheck without worry when school starts.

Given the numbers above– the HELOC rate isn’t terrible, but it’s not low enough to make investing the difference a slam dunk.  Personally I’d figure out how much you intend to contribute to the 403(b) and get that started with the school year (so that it goes on auto-pilot) and then decide on the IRA after all the renovation stuff stuff has been figured out or April happens, whichever comes first.

#2 says:  Pay cash because it takes time to open a HELOC (apply, get approval, etc.) and you want the reno done ASAP so you can move in and not go insane.

Grumpy Nation:  What are your thoughts?  Any experiences with HELOC/2nd mortgages/renovations/etc.?

14 Responses to “Ask the grumpies: Pay for renovation in cash or take out loans?”

  1. yetanotherpfblog Says:

    I would take out a HELOC and then pay it off in a few months. Even in that scenario, I wouldn’t invest the excess cash, though. Access to liquidity during a renovation is extra important, especially if you’re working on a compressed timeline to get everything done before move-in.

    My story: A few years ago I bought a place that needed significant renovation work. I had just enough money, I thought, for a 20% down payment plus the renovations needed to fix up the place. Unfortunately, renovation costs ended up being *much* higher than I had anticipated and it ate through all my cash. It got to the point where I had to time payments to my contractors versus my paychecks so my checking account wasn’t in the red. If I had just opened a HELOC or construction loan in the first place, even if I didn’t end up using it, I could have avoided a lot of sleepless nights. I would not have wanted to wait to make the decision deep into the renovation (my mind was in a dark place; renovations are stressful). I also ended up doing no-cost refinancing soon after the renovation anyway. So if I had gotten a subprime loan when buying, even, the rate would have only been temporary and probably worth it to get the extra cash. But that was all before the Fed was aggressively hiking up rates.

  2. Leigh Says:

    I have done some HELOC research (to have as a backup) and most of the places I talked to would only give a HELOC up to 80% total debt on the value of the place. So if you put 20% down on the new house, they might not give you any. Or if they do, the interest rate would be substantially higher.

    I don’t know how long your planned Reno projects will take, but my condo association recently had to do some large work and we paid 50% as a deposit and only had to pay the other 50% when the work was satisfactorily completed.

    I don’t know how much you think the transition costs will he or what your monthly expenses are, but it seems possible for things to work out without a HELOC to me and I’d rather avoid the debt myself.

  3. bogart Says:

    Unless Ellie is already planning to max out her tax-sheltered retirement savings contributions, I’d prioritize doing that over avoiding a HELOC and take the HELOC (assuming doing so is feasible). I might also look into whether any of my credit cards are offering teaser rates and use that as a short-term borrowing strategy if the desired length of loan really is only for a year or 18 months.

  4. Matthew Healy Says:

    Never done a HELOC; when I did renovation I paid cash. But do remember the Three Laws of Renovation:

    1. It WILL cost more than you think.
    2. It WILL take longer than you think.
    3. You know Laws 1 and 2 so you have a mental “surprise factor” in mind. Won’t be enough. Never ever.

  5. chacha1 Says:

    I have no experience with HELOCs but I do have experience with renovation and I say get ‘er done as fast as you can because QOL is, IMO, extremely important. Just because you have a new job (which presumably you are happy about) and have been able to sell one house, buy another, & move without undue trauma does not mean there will not be other major lifestyle modifications, and unanticipated emotional adjustments, associated with the move and the new job. Get the nest feathered.

    That said, Matthew is right.

    For income security in the near term, I’d simply reserve the amount of cash you project will be needed to cover the unpaid 3 months. Then plan the Must Do’s very carefully, and make that list as short as possible.

    For me, Must Do’s were the bathrooms, a new countertop and sink in the kitchen, and a new sliding-glass door to replace a sad old window so that we could actually see into, and walk out into, the back yard. Oh, and a new back door with half lite. That was a quick/easy/cheap fix that made a WORLD of difference.

    (The new floors and new wiring were also Must Do’s but were in the hands of our landlords. New floors: stressful but not too time-consuming, and not really that expensive since I went with a big-box laminate. Wiring: stressful, lengthy process that fortunately didn’t cost us anything because damn.)

  6. rose Says:

    Such good advice!!! Impressive.

  7. jasonedwards57 Says:

    I would say pay this in cash. In my opinion, there is really no good debt. You are always beholden to someone (e.g. bank, etc). Yes, I know there are some gradations there, but I would want my life to be clean, particularly with the stress of a new job. No need to add stress on top of that with a HELOC. Pay cash and if you want to beef up the savings a bit live like a college student for a few months. Also, typically mortgages have about a 60 period before your first payment. So if the first payment is not due say until October or November that gives one the opportunity to pile up a little more cash. And in the interim I might just live very cheaply for the next few months until the move and get all the ducks in a row.

  8. First Gen American Says:

    99% of the time I am a pay as you go person.

    We did one home equity loan when we were consolidating down from 2 houses to one bigger house with inlaw as money was tied up in the other homes. Our “must dos” were things like roof, heating system and foundation work. The roof was leaking and we couldn’t get insured or move in without a new one. It was unquestionably a need, not a want. So first ask..are these Reno’s needs or wants and can you wait on them if you had to?

    Second, like a previous poster said, It does take longer, it is more expensive and 4 months in, we were unexpectedly down one income so we were glad to have the extra liquid cash.

    It is easier to throw money at a problem and just get er done with the line of credit even for someone who is frugal because big Reno’s are stressful and at some point you just pay the cost and deal with it later.

    I’m the end people have different levels of debt tolerance. The question you really have to answer is: Will it be more stressful with extra debt and interest hanging over my head or with a tight cash flow for a while?
    If you are really bent on certain savings goals then tight cash flow is a type of forced discipline. If it will just pile on too much stress with all the other life changes, then do the loan. Just expect that you will owe more overall in the end.

    Last but not least, rules on loans vary by state so not all this advice may be pertinent to where you are moving. For example in MA you can’t get do free closing costs refinancing (where I think the costs are lumped into the mortgage payment).

  9. Ellie Says:

    Thanks Nicole & Maggie, and thanks Grumpy Nation! Lots of good, much appreciated food for thought here. Still some final numbers to crunch, but I think in the end I will go the cash route given the uncertainties of HELOC rates vs. investment returns. Then, once things settle down, not having the monthly HELOC payment will allow me make up the retirement contributions.

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