Your home is most likely your largest single asset. Home improvements enhance that investment—which is smart thinking. What is not smart, however, is that many homeowners neglect to consider how paying for that home improvement is going to affect their other investments outside of the home.
Let’s take cash for instance. When you pay for a remodeling project in cash, you tie up funds that could be earning interest in other accounts, mutual funds, CDs, or other investments that provide returns. You also lose the opportunities to invest those funds, pay for hardships, medical expenses, or even a vacation (called “opportunity cost”). When you liquidate an investment to pay for a project in cash, you are not only paying for the remodeling work, you also are paying for the lost return on that investment you no longer have—which is a real cost, involving real money.
You also lose a tax deduction by paying in cash. You cannot write off a cash improvement as you can the interest on a home improvement loan. Before you pay in cash, compare the interest rate on the investment you are preparing to liquidate (even if it is a savings account) to the interest rate on the home improvement loan—then add on the tax deduction. Financing may save you money.
If you are going to pay cash for some personal use, it is far better to pay cash for a car and finance the home improvement. You can’t deduct any interest on a car loan, you can on a home loan.
Always review your plan with a tax/financial advisor to determine the best option for you. Often remodeling can be as good an investment as the stock market or CDs.