Here's Why It Pays to Finance Home Improvements -- Even if You Have the Cash in Savings
KEY POINTS
- If you pay for home improvements outright, you might leave yourself with insufficient savings for emergencies.
- Financing renovations could make it so you don't have to borrow in a more expensive manner down the line.
Improving your home could not just raise its value, but also make your life more pleasant and convenient. Let's say your house has an unfinished basement. Turning it into usable living space could make it so your kids have a place to hang out -- and your living room isn't constantly filled with toys.
Now many people who wish to renovate their homes have to borrow money to do so, whether in the form of a personal loan or a home equity loan. But what if you have enough money in your savings account to cover the cost of your upcoming project?
You may be eager to avoid borrowing -- especially at a time like this, when it's gotten expensive to sign a loan in the wake of Federal Reserve interest rate hikes. But pulling the money from your savings to pay for home improvements outright could end up being a big mistake.
Don't leave yourself short for emergencies
Let's say you're looking at a cost of $40,000 to finish your basement and you happen to have $45,000 in savings. You might assume that you're better off taking the cash out of your personal account than having to sign a loan and pay interest on it -- especially at a time when borrowing rates are high.
But let's say you go this route and leave yourself with just $5,000 in savings. What happens if, a few months later, your air conditioning system breaks and you need $7,000 to replace it? Or, what if you end up losing your job and being unemployed for a period of time? At that point, your remaining $5,000 in savings might really fall short.
That's why it's not always such a great idea to pay for home improvement projects outright -- even if you technically have the cash. You don't then want to land in a situation where you don't have an adequate emergency fund.
Of course, there are different definitions of what that is. Some financial experts will tell you to reserve enough cash to cover a year's worth of bills. Others will tell you that six months' worth is fine.
But at a minimum, you should really try to leave yourself with enough cash in savings to cover three full months of essential living costs. So going back to our example, let's say you have $45,000 in savings and you pull $40,000 for your home renovation. If you normally spend $5,000 a month on essential bills, you'll be left with cash to only cover one month of expenses in the event of job loss. That's not so good.
Conserve your savings
If you have lots of money in savings and can afford to pay for home improvements while leaving yourself with a solid emergency fund, then by all means, don't borrow. The Federal Reserve has raised interest rates 10 times since March of 2022, and that's led to higher loan rates even for borrowers with good credit.
But if pulling money from your savings for home renovations means leaving yourself short on funds, don't do it. If you go this route, you might avoid paying interest on a personal loan or home equity loan that's only moderately expensive. But you might then end up having to charge unplanned expenses on a credit card whose interest rate is likely to be considerably higher. And that could mean entering a dangerous cycle of debt, rather than taking out a loan with manageable payments.
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