In a perfect world, I'd rather you not borrow money. But sadly, we don't live a perfect world. And if a person is going to borrow, I'd like them to at least borrow in the best way. This seems like the abstinence/safe sex conversation, doesn't it? If you need money, and must borrow, then you need to inflict the least amount of damage possible. In addition, you must also have a realistic, aggressive plan to pay off the debt you incur. Don't exhale after you borrow the money.
Unfortunately, people tend to exhale after they make a purchase funded with debt. Buy a new car - exhale. Buy a new house - exhale. Finish your basement - exhale. Hell, many people even exhale after purchasing consumable goods with their credit cards. You just can't to do this if you expect to not regret using credit. In many instances, you can prevent the exhale problem by avoiding debt altogether. Pre-funding a financial goal causes a person to exhale at the same moment that they financial obligation in vanquished.
I recently received an email that gave me the perfect opportunity to discuss this lesson.
Pete – thanks in advance for the advice. Kitchen remodel project - $75k. Live in an area where home prices are solid - $300k area. We have $120k left on a 15yr refinance. Could pay cash for the entire project, but would put a significant dent in our liquid cash. Line of Credit looks to be in the 5% range from our bank. Not sure if Home equity is much different. Don’t think we want to refinance again as we’re at 2.85% now. Could pay off rather quickly – within five years max. What do you think? - Timmy
Timmy? What grown man is named Timmy? Kidding.
I love this question. In fact, I was in a very similar situation with our basement remodel. I'm not necessarily suggesting that you do it the way I did it, but I will tell you what I did. We saved, from scratch, the tens of thousands of dollars for the basement, once we had set it as a goal. I can't tell you how glad I am that we did that. I don't have to worry about the cost of the basement ever again. I exhaled the moment I wrote a giant check to the contractor and walked into the finished basement for the first time.
That being said, here's the question you need to ask yourself: Are you more likely to hustle to refill your cash over the next five years or pay off the debt? You shouldn't take your cash down below three months expenses, but if you have cash in excess of that, then you might consider using it. I find that most people are more likely to hustle to refill cash than they are to hustle to pay down debt.
If you go the debt route, then you can probably get a HELOC with a lower interest rate than just the line of credit, plus the interest payments will be tax deductible.
Either way, you need to identify the free cash flow within your current budget that is going to go to pay down the debt on a monthly basis. Does that make sense? -Petey