8. Do's and don'ts of credit-card financing
Financing a renovation with plastic can have advantages, and serious risks. On the positive side, many credit cards offer airline miles, cash back or other incentives for charging up large sums. If you are looking at tens of thousands of dollars, a 1-percent cash-back offer could mean hundreds of dollars rebated to you just for swiping your card.
If you want to use credit cards to take advantage of a teaser rate or a points program, one less risky way would be to apply for a HELOC before charging up a large balance. That way you don't have the high credit balance pulling down your credit score when you are applying. This method is risky, though, because if you are so much as an hour late on your payment, the bank could charge you interest retroactively for the entire term, wiping out whatever benefits you were able to eke out.
The serious drawback comes when you fail to repay the entire balance at the end of the grace period. While getting a $100 rebate check is nice, annual interest rates of 18 percent or higher quickly erode and eliminate any headway your cash-back offer might give. That should not be the long-term financing vehicle that you use. Credit card money is very expensive. You are typically much better off getting a home equity line if you are looking for a way to carry a balance.
9. Squeeze money from home improvement stores
You can often find very attractive promotions through home improvement centers, 5 percent to 10 percent off a major purchase from The Home Depot or Lowe's, or zero interest for a year on windows from Sears.
Those promotions are meant to drive up sales. As long as you follow the rules to the letter, they make sense. But, just like with credit-card offers, a missed or late payment, even by a day, could set off retroactive interest rate that wipes out the benefit and more. Also like credit cards, it is often a good idea to have a refinancing method lined up before you commit to the charge. That way you aren’t stuck with an expiring promotion and no way to pay it off.
10. Watch out for loans from a contractor, family member or other private party. Some contractors will "help you out" by offering to front money for repairs, but be careful, as that contractor loan, as with any private-party loan, is an incredibly risky proposition. That's because commercial lenders use standard documents and would be less likely than a private lender to slip in onerous clauses.
If you are borrowing from family, make sure you know what you are getting into. While many families get along just fine, introduce money into the equation and you could be putting your relationships at risk. Think hard about these options.
11. Cashing in on cash-value life insurance
Cash-value life insurance policies, called whole life, universal life and variable life policies, or "permanent" insurance, create pools of money. As you pay into the policy, part of the premium goes toward a cash reserve. The insurance company invests that reserve and it grows tax free. The reserve is meant to subsidize your premiums later in life when insurance is more expensive as a way to keep your policy costs consistent. Yet you often can borrow from that reserve, and generally at a much lower rate than a bank might offer.
The main drawback, is that, typically, loans from insurance policies have no repayment schedule -- you can pay it back at whatever pace you deem appropriate. However, interest accrues every month and you receive an invoice every year for that interest. If you fail to pay it back, it gets rolled back into the loan, and your principle amount grows.
If the loan grows larger than the cash value, the policy could lapse and you could be hit with a big, unexpected tax bill. And, if you die before the loan is paid back, your death benefit shrinks by the amount still outstanding on the loan plus interest. Cheaper, term life insurance rates have plummeted in recent years, calling into question the wisdom of buying higher-priced policies. When you borrow against your policy you are still required to pay it back unless you lower your death benefit. This is not typically a good idea.
12. Take it out of your 401(k)
Most 401(k) retirement plans allows participants to withdraw loans for five years with no tax implications. Some policies allow you to withdraw the money for any reason, while others limit loans to health-care emergencies, to pay for education or for home improvements. While borrowing from yourself may seem like a wise money move, financial advisers uniformly denounce the idea.
The 401(k) option for home remodeling is not a great option for most because people don't save enough as it is. Even though you are paying yourself back with interest, you miss the chance to compound that money over the five years it is out of your account. Depending on how much you borrowed and how far you are from retirement, that lost compounding could translate into tens of thousands of dollars in lost income. That should be reserved for life-threatening situations and not a remodel of your home. Probably makes more sense if you are very young and have many years to continue contributions to your 401K.
Aside from the lost compounding, if you are fired or leave your job the loan comes due in full with interest. If you can't repay it, you get hit with an additional 10% early withdrawal penalty.
Thank you to Bankrate.com and Yahoo Finance for portions of our research and article details.
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