I won't use home equity to pay for renovations
Several years ago, my husband and I purchased a home that I would describe as a moderate fixer-upper.
There were — and still are — plenty of unsightly things to improve: an unfinished wall and cheap plastic crown molding in the living room, dirty carpets in the bedrooms, and a cracked, 50-year-old, yellow-speckled tile kitchen counter.
We paid cash to fix the flooring and living room issues before we moved in, and we recently remodeled our hall bathroom, but we've left all the other projects for later.
We don't have granite counter tops. Our oven and furnace are decades old. Our kitchen appliances are all different colors. We don't have air conditioning.
Why not just take out a home equity loan and bring our house into the 21st century?
We work hard. We deserve nice things.
Interest rates are around 6.0% for a $30,000 home equity loan right now, and we have enough itemizable tax deductions to fully deduct the interest payments from a loan.
For $30,000, we could probably make every home improvement we wanted.
Say we took out a loan with a 20-year term. The monthly payment would be just over $200, which is affordable for us.
But the total cost of the loan over two decades would be more than $50,000.
Even after the tax savings from deducting $20,000 in interest, that’s a hefty price to pay for impatience.
Plus, by the time we finished paying for our improvements, many of them would be out of date. No financial planner would tell you to borrow money to purchase a depreciating asset.
We don't need to improve our home's resale value — we're not planning to sell in the next couple of years.
If we wanted to move sometime in the next 20 years — a real possibility — we’d have to repay the home equity loan first. That’s more money we’d have to get from selling our home just to have the option to move.
Bottom line: We don't believe in spending money we don't have. The only debts we have are our mortgage and student loans.
And we really don't believe in putting ourselves at greater risk of foreclosure just to have a prettier kitchen.
A home equity loan is a second mortgage. That means the bank can take your house if you stop paying your loan, just as it can if you stop paying your first mortgage.
The default rate on second mortgages is actually lower than you might think. In June, it was just 0.54%. That’s the lowest default rate in the history of the S&P/Experian Credit Default Indices, which measure how many consumers aren't able to repay their loans.
By comparison, the default rate for first mortgages was 1.23%; for bank cards, 3.41%; and for auto loans, 1.00%.
It seems unlikely that we’d default on our home equity loan with numbers like these.
But in 2009, the default rate for second mortgages was higher than 4.5%. Given the cyclical nature of our economy, it’s likely that we’ll see default rates like these again.
We also haven't succumbed to the temptation to upgrade our home using a home improvement credit card with a 0% introductory APR or a 5% discount on all our purchases.
It's too easy to slip up and owe back interest with these cards, and again, we'd be spending money we don't have.
For all of these reasons, we're not borrowing to improve our home.
I don’t like to limit my options by having too many recurring expenses, and I don’t like to pay more than I have to for anything.
Not having a giant pile of cash at our disposal has forced us to choose our home improvement projects carefully and to be frugal in the ones we pursue.
Can we get through another summer without air conditioning?
Why not? We did it the last four years with fans and ice packs.
Do we have an attractive stainless steel oven, range and dishwasher? Is our furnace quiet and energy-efficient?
No, but they all work.
Not borrowing means waiting, sacrificing and saving — sometimes for years — before you can get what you want.
But it also means being able to sleep at night knowing you haven't gotten in over your head financially, and it means you can fully enjoy the improvements you do make knowing you saved up and paid cash for them.