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.?
