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.?

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Options for handling the long unpaid summer

Academics and teachers are often on 9 month contracts rather than 12 month.  That means that there’s often not a paycheck coming in for 3 months out of the year.  For folks used to budgeting the 9 month paychecks as if they were 12 month, that can be a problem.

There are a number of different ways that people deal with the summer months.

Let the school do the math

Perhaps the easiest (though not economically optimal) is to ask the school to prorate the 9 month salary and pay it over 12 months.  Not all schools offer this option, though some offer it as the default (it is very common for K-12 teachers, for example).  The benefit to doing this is that no planning needs to go into this option.  The negative is that you get three months worth of income later than you would have otherwise, which means you miss out on debt repayment savings or investment gains while you wait.  Back when she was an academic, #2 chose this option. She calculated the interest she could earn on the extra money if she got it over 9 months, and it was something like $11. She decided it was worth $11 to her in order to get the same amount of money every month.

Get more $

An attractive option is to earn additional summer money, although this requires extra work.  Summer money can come in the form of teaching summer classes, taking on additional administrative roles, or getting summer money through grants.  For people who do not have university options, it is possible to take on another job or make some additional money via consulting.  #1 loves getting grant money, but it doesn’t happen every year.

Another attractive option is to be married to someone who makes enough money to live on during the summer without having to save, although this requires either luck in love or sacrifice.  This option requires not lifestyle inflating to the point where you cannot live on the spouse’s salary alone for three months.  This summer #1 is sort of doing that, but with a hefty back-up emergency fund that she’s been saving to refill after our most recent car purchase.

Save when you’re paid

For many of us, saving is the best (or only) option.  There are different ways to save.

If you generally make a lot more than your expenses, you can just save what you don’t spend and then figure out what to do with the leftover money in the Fall when you get your first paycheck of the new school year.  This method requires you to be putting away more than your required summer expenses during the school year and to be able to moderate your optional expenses based on how much you have in the bank.  This method is basically what we did the first few years when we were living like graduate students on professor salaries.  That additional money would end up going into IRAs every October.  Ironically, this is how we handled money when we didn’t have as much money because we also didn’t have enough of an emergency fund to have many luxuries built into our budget.  As our savings and income grew, we were able to take more risks with spending (ex. eating out once or twice a week), and our monthly spending has become more predictable.

If your gap between income and spending isn’t that large, then you’ll need to do some math.  You can figure out the expenses needed for 3 months, by taking your annual expenses, dividing by 12 and multiplying by 3, though if any big bills come due in the summer (property taxes, life insurance, etc.) those will also need to be taken into consideration.  Then you can save up until you hit that target number.  Alternatively, you can divide the total amount needed by 9 and put the same amount away every month, possibly via an auto-deposit.  #1 saves up to the Target number and then pads it with some additional emergency fund (the emergency fund part is larger when her DH is unemployed than when he is employed– likely this summer most of that money will just roll over to next year).

If you have the resources or have problems with impulse control, you can put money in CDs or Termshares that come due when you need the money in the summer.  Some credit unions also allow “Christmas clubs,” where they automatically deduct money from your account that you can’t touch until a pre-determined date, that are more general than just saving for Christmas, though they generally charge you money rather than giving you interest for the option.  Back in grad school when #1 got paid 2x/year, she put a significant portion of her first paycheck into a CD due 9 months later so that we’d have money to live on during the summer (interests rates were high and my income was low, so the $200 or so that we got in interest via doing that was highly welcome).

If you have a lot of resources, you can undrip dividends from stocks during unpaid months, though it’s not clear this would be optimal unless you have a lot of wealth but not a lot of income (maybe if you’re one of those mythical trust-fund humanities profs that people on the Chronicle forums loved to complain about).

Trick yourself

Sometimes it is just hard to save money when you have it.  When that happens, it is likely that the summer will be leaner than it should be.  There are a few ways to trick yourself into spending necessary money when you have it so you don’t have to pay it when it runs out.  For example, you can prepay required summer expenses like insurance or summer camps during the paid months.  Another thing #1 used to do when money was tighter was to put off getting reimbursements for things like daycare or credit card rewards until Summer– those little credit card rewards were really helpful when checking got low near the end.  Another trick is to put reimbursements and other “found” money in a bank account that is separate from your main one and then only tap it when you need it or make regular transfers from it in the summer.   #1 is a big fan of hiding money from herself in online savings accounts as a way to decrease unnecessary spending.

Those of you on 9 or 10 month contracts, give or take, how do you handle the unpaid months?

Ask the grumpies: An invitation to rant about @#$@# who think 300K/year (or more!) is middle class.

Anoninmass requests:

I just read on another blawg a comment that declared $400,000 a year was middle class. Discuss…

Chacha1 asks:

what does “middle class” even mean, anyway?

Clearly we think that idea is ridiculous.  Even in Manhattan.  There’s not any set definition of middle class, even in economics.  I think in practice we mostly use Obama’s “Under 250K” definition, even though that’s from a couple presidential campaigns ago, or we use something like 25th percentile to 75th percentile of household or family income.  If you’re curious, that’s something like 29K to 106K for household income .  There might be adjustments for cost of living, but cost of living isn’t going to get to 400K.  You can also look at median incomes by state, but with the caution that you shouldn’t cut the geographic area too small– it is likely that 400K complainer is living in or wants to live in a big house in Atherton or one of the nicer LA suburbs or Battery Park in Manhattan.  There are plenty of places in the same commuting zones with decent schools that have wider ranges of income and housing prices.  (And even there, 400K is well above median household income!)

Anyway, we don’t need to go on too much at length as this topic went around the blogosphere this past Spring.  Here are some links worth reading.

Is frugality inspiration porn?

Fire Blogger Manifesto– why it’s important to be transparent about income.

Who is the audience for this blog?  (This one also has especially great comments.)

Some forum commentary on the FrugalWoods higher than expected income.

Delagar discusses life in the lower middle class when you started out with medical debt.

Here’s another forum thread on why the post from Financial Sam about needing 300K/year to be middle class in SF is so much BS.  (I’m leery about sending more traffic his way though because that rewards him for spewing crud.)  That post did finally get me to stop clicking on his click-bait headlines when they pop up in blogrolls though.  He’s another blogger with an extremely limited lens.  His post probably emphasizes the point most of all (by the way he completely misses it) that middle-class people have to make trade-offs within the set of middle-class lifestyles.  If you can have all of the variants of middle-class lifestyle (geographic location, house, schools, cars, vacations, no college debt, insurance, stuff, no real money worries), then you’re not actually middle-class.

Middle class:  What everyone claims to be, but nobody knows what it actually is.

Discuss

Vanguard Admiral Shares are pretty cool

I wanted to add a little more international exposure to our portfolios (if I’m reading things correctly, the IRA Roth is a great place to put international exposure because there might be higher taxes with international stock gains?  I’m not 100% clear on this– I also read something that said the opposite), so when we recently did backdoor Roths, I put the money into an international index and an international ETF.   The index (VGTSX) has an expense ratio of .18% and the ETF (VXUS) has an expense ratio of .11%.

If I have 10K invested, then I can convert my VGTSX investor shares into  VTIAX admiral shares, which will decrease the expense ratio from .18% to .11% (same as the ETF).   For most of the index funds that have admiral shares at Vanguard, the switch from more expensive investor shares to cheaper admiral shares occurs when the account has more than $10,000 invested in that specific index.  Basically Vanguard gives you a discount on the index if you have a lot invested in them.

My 2017 IRA investment was only $5,500, but it is a new year so I contributed another $5,500, which, if the stock market doesn’t crash, adds up to more than 10K, meaning I should be able to switch to admiral shares to get the lower cost fund.  So that’s what I’ve done.

I’m wasn’t entirely sure where to invest DH’s IRA this year.  He had less invested overall and thus needs less international exposure and already had the lower cost ETF.  (I know that since we’re living in a community property state that I should be looking at our accounts as a complete whole, but since I don’t know what the future will hold, I want to make sure that he’s also protected.)  I will have to see what holdings he currently has one of these days.  I suppose we’re due for one of those financial fitness days sometime so I can go through and readjust our assets etc., but maybe I’ll wait another year.  We’ve got a lot of stuff going on and can afford to put it off, especially since I’m not really sure what asset mix we should be aiming for in the first place.  In the end  I gave him more VXUS.

Do you pay attention to expense ratios?  How do they change your investment patterns?  Any preferences between Index vs ETF?

Thoughts on ways to become more obnoxious with money

I was reading through the Gourmet magazine cookbook I got for my birthday the other day (used because Gourmet is sadly defunct).  In the entertaining section it has a couple of pages recommending that when you throw a party, you just hire caterers and be sure to rent 3x the wine glasses you think you’ll need.  I guess not unexpected advice from a book that starts with 33 pages of cocktails*, though perhaps a bit unexpected from a cookbook that one has bought, presumably, to cook the recipes therein.  I’ve been to catered parties for work, but I’d never thought of actually throwing one myself.  In fact, other than Thanksgiving and the occasional playdate (either DC1 or DH will have a friend or two over to play boardgames, and/or in DC1’s case, video games), we really don’t throw parties at all.  That year in paradise we would have people over and we’d get take-out (usually dips and salads from the local Israeli place), which is sort of like catering, but much less expensive.  Here, presumably, we’d go into the city the weekend before throwing a party and get lots of frozen canapes from WF and TJ’s to reheat.

The military couple who owned our house before us set up the kitchen for caterers with lots of warming trays and heat lamps and an entire wall of our huge pantry filled with alcohol (the side where we keep tupperware, plastic cutlery, the mini fire extinguisher, extracts, and where the children keep their personal candy stashes).  So maybe catering is something that “normal” upper-middle-class people do, or more likely, they catered a lot of work events so someone else was paying.  The state-side military seems to be into government funded catering.

I wonder at what income/wealth point people hire personal assistants and if we will ever get there.  I’m guessing not.  (What would we use a personal assistant for, you ask?  This weekend we decided that finding a competent handi-person was too difficult so DH is in our back yard pressure-washing the deck himself and after it dries, 3/4 of us will work on staining it.  A good personal assistant would find a handi-person and negotiate a reasonable rate for hir services.  Similarly this PA would find a reasonable yard service that doesn’t have to be told every single week not to cut the grass so short, not to use leaf blowers, etc.  So, I guess a good PA would mainly find ways to spend more of our money.  I’m guessing we will never get to that point.)  I do know economics professors who have personal assistants, but they’re dual-economist couples at top schools who are jointly making somewhere around $500K/year (or more).  So, maybe the answer is $500K/year, adjusted for inflation?  Must be nice.

Is this why obnoxious people say you cannot possibly be rich in the Bay area on a mere 300K/year?  Because they can’t afford to live the life of movie stars from the 1930s?  Is this why the evil rich want more income inequality, so it’s easier to hire competent servants?

How could you become more obnoxious with (lots more) money?  Giving to charity or saving it not allowed for this thought exercise!  Hiring a toothpaste sommelier, on the other hand, is totally allowed.

*Two thumbs up for their Moscow mule.  Also the chocolate egg creme.

obnoxious ramblings on income, unearned income, taxes, and so on

  • We made 17K (!) in non-W2 income last year.  Some of that was honorarium and consulting (1099) and some of that was dividends and unwanted capital gains (I really need to do *something* about American Century Trust and its irritating habit of creating capital gains which it then reinvests in itself.  It didn’t used to do that.  But now it does.  Just selling it all will create an unpleasant tax situation come tax time, but maybe I should bite the bullet.)
  • I don’t know what the breakdown between stocks and 1099 income is because DH mentioned this to me while he was trying to figure out our estimated tax situation for next year.
  • He told me that our estimated taxes for next year would be 17K and I almost had a heart attack.
  • Then I was like, wait… that can’t be right.  What was our non-W2 income?  We can’t be paying 17K in taxes on 17K of estimated non-taxed income.
  • Then I said, on top of that, I switched all our Roth 401K/457 stuff to traditional (even though I know that’s not the optimal money thing to do, it’s part of my #resisting), so we should be paying lower taxes on top of the fact that we’re in a lower tax bracket despite higher income because congressional Republicans and their oligarch overlords are evil.
  • It turned out DH had not paid any attention to the fact that we put tax-free (for now) money into a required retirement fund (6% of my income), a 403(b), a 457, and as much of a 401K as DH’s non-discriminating test failing fund will allow.
  • Taking that into account brought down our estimated excess tax burden to something like $6K.
  • We decided to take $500 out of each of my 9 paychecks and also send the government a check for $1000.  (They also have a small credit from this year’s taxes because we’d missed a bunch of charitable giving the first time we went through taxes and paid the bill.  Correcting that mistake put us into itemizing range and we saved something like $100, which we applied to next year’s taxes.)
  • Our dividend income may be lower next year because PG&E which provides the bulk of my dividend income is having money problems (specifically, they’re waiting to see how much they owe for the CA wildfires) and has not been paying out quarterly dividends.  That’s about $700/quarter we will not be getting.  This has happened before– when I first got these stocks PG&E was bankrupt (but I still had to pay taxes on money I never got with money didn’t have… long story, but the dividends since have made up for that stress).

What should go where when you’re investing?

Disclaimer:  we are not professional financial planners.  See a certified planner with fiduciary responsibility or do your own research before making important money decisions.

Once/If we stop hemorrhaging money spending on things like new cars and water filtration systems, we may need to start filling up taxable accounts with what we don’t spend.  When you aren’t filling up all of your tax-advantaged accounts, it makes sense to put both stocks and bonds in there, adjusted for your risk preferences and how close you are to needing to withdraw money.  Once you start filling these up, however, and start putting excess money into taxable accounts, it makes sense to think about tax advantages when deciding what to put where.  In general, you’ll want to put things with high expected earnings in accounts (like Roth accounts) where the earnings come out tax free, while you’ll want things with less risk and lower earnings to be in accounts that aren’t tax-advantaged.  If you are not in this situation yet and don’t want to deal with the complications, it’s fine to just pick a target-date fund and set and forget.  Satisficing is better than doing nothing!

Tax advantaged Roth (including dual-advantage):

Roth accounts are taxed when the money goes in, but the earnings are not taxed.  Dual-advantage are things like HSAs in which the money that goes in is not taxed and the earnings are not taxed.  In both of these cases, you want to put your highest earning funds over the long term.  So this will be a good place to put your Nasdaq stock index funds/ETFs and then after that any other broad-based stock index fund that is going to go up over the long term.

Tax advantaged non-Roth (aka Traditional):

These have the earnings taxed when the money comes out, but provide a tax advantage when the money goes in.   If you are not close to retirement, these are long-term funds that you can’t take out without a penalty.  You probably don’t want to play any tax-loss harvesting games here because you don’t really get the benefits of the loss right away unless you’re converting the funds to Roth funds.  This is a good place for putting funds that are going to go up over the long term but aren’t going to go up as much as the stuff you put in your Roth accounts.

Taxable accounts:

Taxable accounts are good for shorter term investing (assuming you’re not close to age 55.whatever) because you don’t have to wait until you’re old enough to tap them without penalty.

If you own individual stocks that might take a loss, this is a good place for them because you can claim that loss against your taxes.

Municipal bonds are tax advantaged themselves, so there’s no point in putting them in a tax-protected fund.

Annuities?  I have no idea.

Bonds, while bonds will have taxable earnings, they’ll generally be lower than those of stocks, so if you’ve maxed out your tax-advantaged funds with stocks, putting some taxable money into bonds is not a terrible idea.  Plus, if you think you’re likely to lose your job during a recession and have to tap into your savings, bonds are better to tap during that time than are stocks.

Have we done any of this?  Nope.  In the past we first didn’t have much tax-preferred investing room, and then we weren’t able to fill up our tax-preferred investing so we didn’t add to any new taxable stocks.  Now that we have so much more invested and we’re maxing out our tax-preferred funds we should think more about what we put where.  It’s a mess.  Because of transaction costs and tax hassles (and the fact that I like that Target Date funds are set and forget so at least a portion of our savings has a reasonable stock/bond/etc. ratio even though they’re not optimal!), I’m probably not going to do much buying/selling of what we have already.  I don’t want to pay capital gains on our taxable stuff right now, especially if we’re just going to reinvest it in a different asset class.  But I will be a little bit more careful going forward.  I’ll continue to fill up our work fidelity accounts with Spartan stock indexes, my 457 with the Vanguard S&P 500 index (their lowest cost option).  If/when I decide we need more bond funds, those will go into taxable.

When we start withdrawing money 15-35 years from now, I will also try to do better when thinking about what we should sell and when.

Do you pay attention to which savings/investment vehicles you put in which type of account?