Personal Loan or HELOC, or "Why No Low-Interest Debt?"

[Dicast]

I'm all for low interest, but I don't see a remodel as a necessity. Why can't it be planned for a couple years out? Keep the money in high yield savings until you hit your number for the remodel.

The other thought on this..you don't state what your current net worth/financial picture really is. You say you can handle the payment but I think it is a much different situation depending on overall status. Already at 2 million and no matter what you will retire at your goal...go ahead and get the remodel now. If you feel like you are behind then I'd skip an additional loan to keep boosting the net worth.

Anything over 3% bothers our household but I've financed a couple cars at >3% because I was going to cashflow the car in 3-4 months...

[wideopenspaces]

I think this post just solidifies why it's good to keep some cash on hand in an emergency fund. You don't have to make choices about selling off funds in a taxable to access your cash and probably a lot less likely to be tempted by a HELOC. I've realized over time I like having the flexibility of having more cash on hand so our EF will grow larger over the next year. We will be looking at a renovation down the road as well ( because we just bought a house with a kitchen last renovated in 91!) And I want to just be able to do it with cash flow once we've figured out what we want to do.

[Anne]

hightower wrote:

Anne wrote:

hightower wrote:

I’m surprised no one has mentioned this yet, but in my mind, the real reason to avoid taking out low interest/zero interest debt for this sort of thing is to help control spending.  The truth is that when you use debt, whether it be a credit card, car loan, mortgage, home loan, etc…you tend to spend more than you would if you forced yourself to pay with cash.

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No one?  What are Zaphod and I….chopped liver?

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I must not have read all the posts very carefully, sorry

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haha, I'm just kidding

[hightower]

Anne wrote:

hightower wrote:

I’m surprised no one has mentioned this yet, but in my mind, the real reason to avoid taking out low interest/zero interest debt for this sort of thing is to help control spending.  The truth is that when you use debt, whether it be a credit card, car loan, mortgage, home loan, etc…you tend to spend more than you would if you forced yourself to pay with cash.

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No one?  What are Zaphod and I….chopped liver?

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I must not have read all the posts very carefully, sorry

[adventure]

(assuming you have self control to not overspend, and pay off the loan ASAP...), one advantage for a HELOC (+ cashflow...) is your ability to write any check - today. As we've remodeled our moneypit, it has been nice to not have to think about cashflow this month, etc, but instead realize if I just write a check for 5k to the (insert trade here), the project gets done - this week, ontime, and isn't dragged out. Having "cash" can buy you a shorter, less painful project.

 

Sometimes your mental health, and ability to move on in life is worth something.

[Anne]

hightower wrote:

I’m surprised no one has mentioned this yet, but in my mind, the real reason to avoid taking out low interest/zero interest debt for this sort of thing is to help control spending.  The truth is that when you use debt, whether it be a credit card, car loan, mortgage, home loan, etc…you tend to spend more than you would if you forced yourself to pay with cash.

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No one?  What are Zaphod and I....chopped liver?  

[hightower]

I'm surprised no one has mentioned this yet, but in my mind, the real reason to avoid taking out low interest/zero interest debt for this sort of thing is to help control spending.  The truth is that when you use debt, whether it be a credit card, car loan, mortgage, home loan, etc...you tend to spend more than you would if you forced yourself to pay with cash.

I don't necessarily see anything wrong with choosing to pay off your low interest student loans or mortgage slowly if you're actually using the extra cash flow to invest aggressively.  Assuming the stock market continues to behave the way it always has, the math will clearly work in your favor over 20-30 years.  In fact, I am having a hard time convincing myself to pay off the rest of my 84k of 2.6% interest student loans for that exact reason.  BUT, I do not think it's wise to take on new debt for the purposes you describe.  Student loans were an investment in yourself with HUGE returns.  Mortgages are kind of a necessary evil and are easy to get out of if needed.  But, outside of those two types of debt, cars, boats, home renovations, TV's, computers, etc. should be paid for with cash to avoid the possibility of over spending.  Home renovations typically yield terrible returns on money invested.  Do you really want to still owe money on a 20 year old kitchen in the year 2038?  Kitchens and bathrooms typically need to be renovated every 15-20 years if you want to sell your home for maximum value.  Would you want to buy a home today with a kitchen renovation from 1998?

Like Warren Buffett says, "when the tide goes out, you can tell who's been skinny dipping." (or something like that, he's said it many times). You don't want to be in a situation when the stock market crashes and/or the housing market recedes, and you're carrying around a bunch of consumer debt for cars and kitchen sinks, etc. It would be far better to be debt free in a bear market so you can maximize your cash flow into buying cheap stocks.

Some debt is okay, but you have to be careful not to fall into the over spending trap by using "cheap debt" as your excuse to buy more crap.  Cash flow those renovations!

[AlexxT]

There's nothing wrong with using leverage to increase returns.

Just keep in mind that leverage works both ways.  Leverage is how wealthy people go broke.

If you don't owe anyone any money, then you can never go bankrupt.

Leverage makes sense if the interest spread is greater. If you were paying 0.5% for your HELOC, then most of us would say you should go for it.

Once the rate exceeds 4%, it's not so attractive.  At 6%, there's little to be gained.

Ask yourself, if you had your mortgage all paid off, would you take out a 30 year mortgage and invest it all in the stock market?  If yes, then use the HELOC.  If no, ask yourself why not.

Have you seen your investments drop in value by 50% or more?  If you had you might be more cautious.

Do you own bonds?  If so, they are probably paying you less than you will be paying the bank.  Why would you borrow at 4% to invest at 2%?

Are you smarter than the bank?  They can invest in the stock market too, but they would rather lend you the money than invest it.  Maybe they know something you don't.  ( Yes, I know there are other reasons why, but still...)

Bottom line, you didn't just think of something new. There's a reason why most of us are saying no.   But it won't make or break you either way.

[Zaphod]

The other thing people forget in these calculations is inflation.

The thing the other side forgets is behavioral, it is very very difficult not to overspend when you take out a loan vs. cash. Im not sure its ever happened. You will spend less for sure with cash, because it hurts. Home renovations fall squarely into unnecessary consumptive items, and thats fine, but play accordingly.

[JBME]

Have you already looked into how much the loan would be and what the interest rate would be? Not adverse to debt here either...we carry a mortgage and medical school debt and both are around 3.5% interest (fixed). We also got a HELOC when we got the house. But that was 6 years ago when rates were low and interest was 5%. It was ARM and I'm sure the HELOC you get would also be ARM. With rates already higher (our 5% is now 6.5%) and just going up...likely at least 0.5% by December of this year, we're trying to get rid of that ASAP while there's no interest in getting rid of the two other loans ASAP.

For your situation I really would strongly advise against taking out a HELOC and just save up the cash to do this. I suspect you have the means to eventually get all the cash you need, and the interest on HELOCs are only going up in the short and probably medium-term future. I know when we get around to a renovation it's going to be paid in cash.

[Zaphod]

rxor49 wrote:

Look at it this way. You are considering taking on debt in order to maximize your exposure to the market (and the risk that comes with it). In the booming market of the past decade, that strategy would have served you very well (retrospect). However, if the market were flat or down over the past few years instead, you would have come out ahead by paying down your loans instead of maximizing market exposure. No way to predict which strategy will prevail in the future.

Maybe another strategy to consider is to just use your cash flow for the project.

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They explicitly are looking long term, 20-30 years. Everyone that assesses these decisions on the day to month to couple year time frame is doing it wrong and its just a justification for whatever path you took. None of these decisions should be assessed on the shorter term, ie, when you'll actually drawdown the other account. If the draw down is soon, then that changes the better choice drastically. If its 20+ years, this will make sense and be a good probability move.

That doesnt apply specifically to the above case but the general. Things are definitely changing, not that itd be a bad move, but the odds arent as favorable as they had been the last couple years. Rates were probably artificially depressed by far too dire economic predictions that kept them lower than the macro situation suggested. I wouldnt take a tax hit to do it, but I'd also not want anything in the 5% range or on a variable rate.

[oxoproline]

Great points from all, and they help unpack some of the complexity of this decision. I'm all for keeping life simple, but am willing to generate some complexity for more long-term wealth, if it makes sense. We do have a design/build team, and they have been very conscientious and cost-conscious, having already suggested a few ideas we hadn't considered that will end up saving us more in the end. The point about the slippery slope of leverage is also well taken. I agree that the 8-10% return I stated was market and not portfolio, although our portfolio is currently 90:10, but it's true that the prime rate has been rising and will probably continue to do so.

[Complete_newbie]

spiritrider wrote:

Some points to consider:

• You are overstating likely returns after a phenomenal nine (9) year+ bull market and not considering a likely reversion to the mean. Most projections are for more like 6% equity returns moving forward.


• You have not included tax drag. You don’t receive nominal returns. You receive net returns after taxes.


• 20 year net returns are close to 6.5% total stock market and 4% total bond market


• You are using market returns and not portfolio returns.


• An 80:20 portfolio has had 20 year net returns ~= 6%.


• The prime rate is 4.75% and the Fed has plans for two more rate hikes this year. They will also likely be 0.25% hikes. HELOCs are usually Prime + (0% – 1.25%). You might be able to get a 1-year teaser rate < 4%, but it would likely be 5% – 6% in a year or two.

I am not one of those people who think all debt is bad. I think there is good debt and bad debt. There are those who categorically say you should never get a car loan. To me it would have been counter-productive to forgo a 1.49% loan for my last car.

There are many people with both mortgages and student loans ~= 3%. I see no reason to pay those off early, but I would personally be aggressively in paying down a 4% student loan.

I certainly wouldn’t be taking out a 5% – 6% HELOC for a voluntary expenditure. I would wait until I had the cash available.

 

 

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Prime rate is a great comment here. Leverage is NOT as attractive as it was few months ago.

[spiritrider]

Some points to consider:

• You are overstating likely returns after a phenomenal nine (9) year+ bull market and not considering a likely reversion to the mean. Most projections are for more like 6% equity returns moving forward.


• You have not included tax drag. You don't receive nominal returns. You receive net returns after taxes.


• 20 year net returns are close to 6.5% total stock market and 4% total bond market


• You are using market returns and not portfolio returns.


• An 80:20 portfolio has had 20 year net returns ~= 6%.


• The prime rate is 4.75% and the Fed has plans for two more rate hikes this year. They will also likely be 0.25% hikes. HELOCs are usually Prime + (0% - 1.25%). You might be able to get a 1-year teaser rate < 4%, but it would likely be 5% - 6% in a year or two.

I am not one of those people who think all debt is bad. I think there is good debt and bad debt. There are those who categorically say you should never get a car loan. To me it would have been counter-productive to forgo a 1.49% loan for my last car.

There are many people with both mortgages and student loans ~= 3%. I see no reason to pay those off early, but I would personally be aggressively in paying down a 4% student loan.

I certainly wouldn't be taking out a 5% - 6% HELOC for a voluntary expenditure. I would wait until I had the cash available.

 

 

[Complete_newbie]

lol this thread again (no offense to OP, more to the inherent basis of the question).

Short answer: Take the HELOC. Its a good move.

Long(ish) answer: Well, this community isn't built for leverage. Check the ads, what do you see? Refi Debt, manage debt, get rid of debt. Its simple approach to reach your destination. Try posting this question on boglehead, see what you get. Point being, math works, the psychology doesn't for majority here (this is not a good or bad thing, its just a thing)

You can extend the same argument to something like this (since you are mathematically inclined and want to be efficient doing it):

- Why not use reasonable leverage to buy stocks, like all the time. Specially when you are young? Run MC and you'll see you are ahead.

- Why use bonds at all? Just go 100% stock all the time. Your portfolio at X age would be so large, you can take swings.

- Why not invest in PE? or small business? Do franchise - 30% return. Beats the market. Who cares about the market.

-  Momentum trading works, set up an algorithm to play swings and you'll be making money.

.

.

Not being facetious. They are true. I have/am doing those. Can you stay the course? Execute it? Life would be complicated? Stress? Those are the questions you need to ask. It'll come from within rather than on this forum. "Personal" finance yo.