I recently had a call with a client looking to fund the construction of a swimming pool. Though they had enough cash to finance the project, they wanted to weigh all their options. This is a question we hear a lot as financial planners. Though home improvement questions often arise, questions about funding a wedding, a recreational vehicle or a dream sailboat are also common.
In most cases, funding large purchases should be thoughtfully planned. As a financial planner, I don’t make judgments about purchases but always recommend that clients take a moment to consider how a potential purchase impacts their overall financial plan and long-term goals. I work with them to quantify those impacts. Once you decide a purchase aligns with your goals, or you choose to revisit and amend your financial plan, you can consider how to fund the purchase.
Cash reserves
Cash reserves are the best option for funding any project. The opportunity cost of lost interest earned will almost always be less than the cost of financing a purchase. However, you must determine if raiding your cash reserves puts you below the recommended threshold to cover any emergency funding needs: loss of job, medical issues, etc. As a rule of thumb, I recommend maintaining six months of expenses in liquid assets.
Investments
These have similar, though usually higher, opportunity costs as using cash reserves. Before you look at this category to fund projects, you also need to consider the tax implications of liquidating an investment. You may also be able to use your investments as collateral to obtain a lower interest rate than a personal loan.
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A home equity line of credit
This can be a good source for financing projects. You want to ensure that your interest rate is reasonable and that you have incorporated the monthly loan cost into your overall budget. If this is a home improvement project, it may be tax-deductible. As always, check with your tax professional.
A 401(k) loan
A 401(k) loan can be attractive because the interest rate is usually lower than other financing sources. However, careful consideration should be given as to the impact on the growth of your retirement assets and that the purchase is not beyond your current means. This may be a good option if you pay back the loan in a reasonable amount of time.
No-interest or low-interest credit card offers
No-interest or low-interest credit card offers can also be a financing option. Typically, you pay a 2% to 3% origination fee to get a short-term loan of six to 12 months with no or little interest. The critical piece is to pay off the loan before the special loan term period expires. Failure to pay off the balance will result in costly finance charges. Most credit card companies will assess the deferred interest, which then makes your low-cost financing extremely expensive. With careful use, a credit card loan can be a good short-term financing choice.
A word of caution when financing any project: Financing should never be used to help you live above your means. It should always be used judiciously and never without considering the impacts on your financial future.
