Finance Home Improvements and Be Debt Free Before You Retire

Casey Fleming

I just came back from a home show this weekend and was taken aback by how much homeowners fear financing nowadays. I understand why this is – after all, a lot of homeowners experienced a lot of pain in the last eight years. There is no question that acting irrationally can be a bad move, and devastating to your financial health when you need it most – when you retire.

But the opposite of acting irrationally is not inaction – it’s rational action.

It was amazing how many folks stopped by our booth who not only had been putting off major repairs or upgrades, but still had mortgages with 5.5% interest rates. Folks delay acting because they had been scared off from acting by all the scary stories they had heard. What’s true and what’s not? Let’s examine the most common myths:

It’s hard to qualify for a loan today

Actually, if you can afford to pay back the loan then it isn’t hard to qualify. It requires what feels like an unreasonable amount of documentation to get the file through underwriting, but remember, this is almost certainly the largest debt you’ve ever had, and lenders had to deal with a lot of bad loans in recent years. A little over-reaction on the part of underwriting is annoying, but not unreasonable. It isn’t hard for a qualified borrower to qualify for a loan today, but it might be cumbersome to get through the process. Be patient, and we’ll get you through it.

And if you can’t really pay the loan back, well then you won’t qualify for the loan. But that should have always been the case.

If I refinance and add years to my mortgage I’ll end up spending more

Actually, this could be true but there is a solution. Let’s say you have 25 years left to go on a 30 year loan, and you replace it with a new 30 year loan. Will your lifetime costs be higher with the new loan? Let’s say we have a $400,000 at 5.375% with 25 years left to pay. We can refinance with a new 30 year loan at 4.500% and $3,000 in costs. (This is just an example – see disclosures at the end of this article.)

You save money each month but pay more over your lifetime
You save money each month but pay more over your lifetime

Looking at the analysis, you’ll see that we can save $429.62 per month, and our costs will be paid back in only 7 months.

But wait! If we make payments as scheduled, we’ll actually pay $11,000 more over the course of our lifetime for this loan. Maybe that’s OK in exchange for a lower payment, but it doesn’t make us happy. What’s the solution?

But pay off your loan over 25 years and you'll save every month and over your lifetime.
But pay off your loan over 25 years and you’ll save every month and over your lifetime.

Well, we can make payments on an accelerated schedule. If we pay it off over 25 years instead of 30, now we are only saving $201.97 per month and our payback period is 14.9 months, but we pay our loan off at the same time we would have paid off our existing loan, and now instead of paying more we save $59,000 over our lifetime. That pays for a few vacations in retirement!

Alternatively, we could get a 20 year loan at an even lower rate. Let’s assume that the going rate today for a 20 year loan is 4.125%. Now our payment is almost exactly the same, so there’s no real savings on the monthly payment. But look at the lifetime savings – $120,000!

Now there is real savings!
Now there is real savings!

The salient point is that the concern about adding years to the mortgage is a legitimate one, but there’s a solution.

It’s better to use short-term financing offered by the contractor

Many folks feel that tying the loan to a specific improvement is a good idea; that way they are paying directly for that specific item, such as a new roof, or solar panels.

There are two problems with that:

First, convenience is rarely cheap. Contractors are not mortgage advisors. They work with finance companies that make the process of financing your home improvements very easy. The price you pay for that is higher fees, higher interest rates (look at their APR!), and aggressive salespeople pushing life insurance and extended warranties on you. You can say no to the insurance and warranties, but the fees and the interest are yours to keep…on paying.

The second problem with that is that you are financing one improvement at a time. You may only need a roof today, but if you need to re-plumb your home in two years you’ll have to either pay off the remaining balance of the roof financing, or consolidate that into a new loan, pay fees again, and start the pay-off cycle all over again.

A finance company is usually the most convenient way to finance home improvements, but almost never the cheapest.

It’s better to pay cash for home improvements rather than finance them

This is true, if: you have the cash or can save up for what you want; there is nothing urgent that you have to do to protect your home (i.e. roof – when you need it, you need it); and you don’t need your money working somewhere else, like investments.  Financing anything you buy adds to its cost.

However, if you do finance your home improvements, I recommend that you pay them off as they wear out, and not more slowly. Most folks refinance into a new 30 year fixed and pull cash out and do lots of improvements at the same time. The problem is that some of the improvements they make wear out long before they have been paid off, have to be done again, and the cycle never stops. Exterior paint, for instance, is something you should not defer and usually only lasts ten years or so. A furnace might last 15 years, a dishwasher 10, etc.

You CAN finance home improvements and still be debt-free at retirement!
You CAN finance home improvements and still be debt-free at retirement!

To solve this, you can refinance and then make monthly payments higher than the minimum so that each of your improvements is paid off before it wears out. A sample analysis looks like this.

Finally, keep in mind that if something really needs to be done – a roof for instance – deferring that improvement may cost you more than financing it and doing it now. You don’t have to have a brand new gourmet kitchen, but you do need a roof, exterior paint and windows that keep the weather from destroying your home.

Maybe it’s time to act

Interest rates are touching one-year lows again; what do you need or want to do to improve your home?

I like it when clients have concerns like those above, because it tells me that they have thought through those things that should matter to them but that few people think about. As I said above, inaction is not the opposite of reckless, irrational action. Thoughtful, fully-informed action is the opposite of irrational action.

When it is time for you to act, you can take action to make sure that your financing is an asset and not a liability.

Casey Fleming, Author, The Loan Guide: How to Get the Best Possible Mortgage

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