Should I Pay Down My Mortgage or Make Home Improvements
Bigg success is life on your own terms. The five elements of bigg success are money, time, growth, work and play. Today our focus will be on money.
One of our listeners, Bob, called us with a bigg question. He and his wife have some extra money and they are wondering whether they should use it to pay down their mortgage or make some home improvements.
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Both options are very illiquid
You can’t get your money back once you spend it with either option. So make sure you have enough extra cash to cover between six to twelve months of living expenses before you do either one.
A guaranteed return
Paying down your mortgage is one of the safest investments you can make. It’s a guaranteed return equal to your mortgage rate.
For example, if your mortgage rate is 6% and you pay it down early, you’re essentially earning 6% on your money guaranteed!
That’s a decent rate of return right now.
Returns on home improvements are often more sketchy. Start by asking yourself this question:
How does the value of your home compare to other homes in your neighborhood?
If you’re one of the most expensive homes already, making improvements probably won’t do you a lot of good financially. However, this is your home. It’s more than just an investment. So ask yourself a second question:
How long do you plan to live there?
The longer you plan to stay put, the higher the emotional returns – an important point to consider because money isn’t everything. What types of improvements yield the best financial returns? Most major outlays don’t return much if anything. Cosmetic improvements usually show a better return – paint, new floor coverings, landscaping, and those sorts of things. Remodeling the kitchen or bath can yield a reasonable return, particularly if they look a little outdated, as long as you don’t go over-the-top.
Weighing your options
Determine how much it will cost for your desired improvements. Then ask a Realtor or an appraiser to find out the expected increase in your home’s value. Now calculate your return:
Return = (Increased Value – Cost of Improvements) ÷ Cost of Improvements
Compare that to your mortgage rate. If the return for making the home improvements is significantly higher, you might consider making the improvements instead of paying down your mortgage.
Just keep in mind, this is not an apples-to-apples comparison. Paying down your mortgage offers a guaranteed return. Making home improvements does not.
Choosing between improvements
If they go with the improvements, Bob wants to replace the windows. His wife wants to remodel the kitchen. Which would be better for the money?
We wonder why you want to replace the windows, Bob. Is it for cosmetic reasons or are you thinking about energy-efficiency? Perhaps it’s both.
Stimulus for you
We hate to disappoint your wife, but right how is a great time to replace windows or make other energy-efficiency improvements. The Economic Stimulus Act extended and improved the tax credit for these types of repairs.
You get a 30% tax credit up to a $1,500 limit. So you can spend up to $4,500 on qualified improvements.
A tax credit is better than the deduction you’re used to getting on Schedule A. Deductions reduce your taxes by the amount of your marginal rate. Credits reduce your taxes dollar for dollar.
So $1,500 of your new windows could be paid for by the government!
The one cash outlay that pays you back year-after-year
However, it doesn’t stop there. It’s amazing how much air can leak out through poor windows. You’ll save money on your utility bills for years with the right windows.
Your returns for making any energy-efficiency improvements aren’t guaranteed but they’re close. They may also be higher than the returns on a lot of other investments these days. Improving your energy-efficiency is a cash outlay that pays you back year after year!
Thanks for your bigg question, Bob!
Do you have a bigg question?
Please share it with us by calling us 877.988.BIGG(2444) or sending an e-mail to firstname.lastname@example.org.
Please join us next time when we talk about two recent examples of saying, “We’re sorry.”
Thank you for sharing your time with us today. Until next time, here’s to your bigg success!
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