Unless you're a Silicon Valley billionaire, it's likely that your largest purchase will be your home. Maintaining a home costs money, and having that money ready takes planning and, sometimes, a little creativity.
Most homeowners tend to under-budget for planned expenses and get caught off guard by unplanned expenses. Do you know how you would pay for a six-figure expense like a roof repair or a new central air conditioner? If not, here are four ways to prepare for the big one-time costs of homeownership.
1. Emergency savings
For those unplanned expenses -- and homeowners will face a lot of them -- it's critical to have an emergency savings account. Many Americans can't even afford to pay for a $400 emergency, and this puts many American homeowners at risk.
Devise a plan to save between three to six months' worth of living expenses that includes everything from home maintenance to food to gasoline. Aggressively save $500 to $1,000 as fast as possible, then set up regular, automatic payments into that account until you have your three to six months' worth of savings.
Bank or credit union savings accounts or money market accounts with no bells and whistles are ideal to use for emergency savings accounts. You don't want to invest this money in the market, because you want it liquid and immune to the market's fluctuations. You also don't want it too easily accessible, so avoid attaching debit cards and check writing to this account. In a real emergency, you won't mind driving to the bank or requesting a wire to access this money. If you have an urge to buy a new television, the effort it takes to access your emergency funds may motivate you to find the money elsewhere.
When you withdraw money from this account in order to cover an emergency expense, treat that money the same way a banker would treat a loan. In other words, withdraw what you need when you need it, then refund it at an interest rate in line with a current benchmark, such as the 30-year fixed rate of about 4%. This has two benefits. The first is that it'll make you hesitate to use this money, ensuring you use it only for emergencies. The second is that it'll add money to your emergency savings account and help you keep up with inflation.
There was a time when many Americans used their homes like ATMs. This didn't work out well. That said, you can strategically use the equity in your home for renovations.
Home equity lines of credit let you use the equity in your home for loans, with your home serving as collateral. Loan sizes are contingent on home values. Because your home is collateral, you can often get lower interest rates than you could with other kinds of loans. Better credit scores will also get borrowers better rates.
There are two phases of HELOCs. The first is the draw, which is typically between five and 10 years. During the draw, you can withdraw up to the maximum amount of your loan. Your responsibility during the draw is to make your minimum monthly interest payments. The second phase is the repayment phase, which is also typically between 10 and 20 years. During repayment, you must make a combination of principle and interest payments to have your loan paid off by the end of the agreed-upon term.
One great feature of HELOCs is that you only pay interest on the amount of money you withdraw on your loan, not the loan amount for which you're approved. If you're approved for a HELOC but never draw on it, you'll pay no interest on your HELOC.
Be careful, though, because your home acts as collateral, so lenders can put you in foreclosure if you miss or stop payments. In extreme cases, lenders can take ownership of your home. Before you consider taking out a HELOC, know exactly what you can afford and how you'll repay it.
3. Introductory credit card offers
An alternative for financing remodels or emergencies is an introductory credit card offer. This is only for the financially mature.
Introductory credit card offers include low-interest rates -- usually 0% -- for a term between six and 18 months. All that interest-free money may sound too good to be true -- and it is if you're not good with credit cards. The reason lenders extend such offers is that most Americans carry balances beyond the introductory period, after which high, non-standard interest rates apply.
Even worse, many Americans miss their monthly payments. Once a payment is late, introductory offers terminate, and you'll face hefty penalties. Before you jump on an introductory credit card offer, read the fine print so you don't forfeit the promotion and your own money.
4. The bank of mom & dad
If no other options are available, you can try a loan from friends or family. It's not ideal to borrow money from friends or family, but sometimes it's all you have.
Allay concerns by clearly setting expectations. Put in writing the amount of money you'll borrow, when you'll start repaying the loan, how long you have to pay off the loan, and what interest rate you'll pay. Both you and your lending friend should sign and date the agreement.
Note that for 2017 the IRS allows gifts up to $14,000 to be exempt from taxation. If your loan from your family member or friend is $14,000 or less, you don't need to be concerned about the IRS. However, if your loan exceeds that threshold, then Uncle Sam asks that the lender charge at least the IRS' approved interest rates. If these interest rates aren't charged, then your generous friend may suffer tax consequences when they file that year's taxes.
Cash still reigns
There are plenty of ways to pay for emergency repairs and major renovations, but the best way by far is to use the hard-earned cash you've saved in an emergency fund. Then there's no lender involved, no (mandatory) interest payment, and no potential to lose your home or retirement savings due to a default. When cash is not an option, make sure you know the pros and cons of your alternatives.
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