Curb the Urge to Splurge
It helps if you have a good plan
By Vivian Astroff
If your dream includes a new kitchen, basement or home office, the costs can easily top what you’d pay for a luxury car.
However, with some planning and number-crunching, you can avoid the slippery slope into unintended overspending.
A good start is to set out a plan with all other ongoing family expenses in mind. Look at the reno cost in relation to the overall value of your house and the length of time you intend to live there. Experts advise setting your total budget at between 20 and 30 percent of your home’s market value. If you have a financial advisor, work with him or her to weigh the various borrowing options so you get the best value for your money and stay within a budget you can afford.
Is Cash King?
Cash is great if you have it, especially for small projects. Putting money aside in a tax-free savings account (TFSA) is useful for this purpose. On the other hand, if you have a substantial sum in a high-interest investment account or mutual fund, withdrawing it to pay for a renovation may not be your best move. Calculate the loss in compound interest that the money would have earned if left in the account, along with any penalties for early withdrawal, against the cost of an equivalent loan. In some cases, a loan might actually be cheaper.
Your credit card could be handy for a small project, for less than $5,000, for example, or to cover ongoing costs like paint or new lighting fixtures. It’s a convenient way to buy individual items at retail stores and track your spending. Otherwise, with credit card interest rates hovering in the 19 per cent range, there’s a big price to pay for the convenience of financing with plastic. On the plus side, you can pay off as much or as little as you wish every month. Also, if your card has a high enough credit limit, you can skip waiting for a loan approval. Some banks offer “secured” credit cards with lower interest rates, but for larger amounts, you still may be better off with a conventional loan or line of credit.
Carrying a balance on a credit card for more than a few months most often comes with a huge cost. If you need to carry this debt, avoid department store credit cards, as these usually charge a premium rate. If a no-interest or no-paymentoption exists for a period of time, ensure this balance is paid at the end of that period to avoid charges.
As an example, RBC Royal Bank offers RBC RateAdvantage Visa ™. This credit card provides clients a low variable annual interest rate and the opportunity to receive a $39 rebate on the annual fee by making their monthly minimum payments on time each month.
Personal Line of Credit
A personal line of credit (PLC) allows you to borrow up to a pre-arranged limit and either pay off the whole amount or a portion of the balance each month above a minimum. This is a popular way to borrow because banks generally have flexible repayment terms with a choice of fixed or variable interest rates based on the prime rate. If you are a long-time client with a good credit rating, you may be able to negotiate an especially favourable rate with your own bank. Banks offer a lower rate if you can secure the line of credit with some sort of equity as collateralsuch as a Canada Savings Bond or a guaranteed investment deposit.
Home Equity Line of Credit or Loan
This is similar to a PLC, but with a lower interest rate, since the equity in your home (its total value less the cost of your mortgage) is considered collateral or security. One glitch is that unless your lenders cover the costs for legal fees and a property appraisal, setting one up may cost you $700 to $1,000. Most mortgages will allow you to take out a home equity line of credit from another lender, so it’s worth shopping around for the best rate.
If your home improvements include major energy-saving features, you may also be eligible for government grants or a lower interest rate from your lender. TD Canada Trust, for example, offers a Green Home Equity Line of Credit at one per cent lower than the posted interest rate and up to a one per cent cash rebate when you buy ENERGY STAR® qualified products.
RBC Royal Bank offers RBC Homeline Plan™ – a smart and easy way to manage all your borrowing needs under one simple, flexible Plan, combining your mortgage(s) and a secured line of credit. This allows both flexibility when needing funds and setting up payment options that suit your cash flow.
A conventional bank loan may be the most straightforward way to finance a major renovation, especially if you will need a large outlay of cash. The rate can be fixed or variable with the option to change during the life of the loan, and lenders usually offer flexible terms, such as your choice of how long you’ll take to pay itoff. The loan re-payments can be made monthly, semi–monthly, bi-weekly or weekly, with the payments deducted automatically from your chequing account and no penalty for paying more than your fixed payment or retiring the loan early.
Refinancing Your Existing Mortgage
This option allows you to spread payments over a longer period of time, often at a lower rate than a secured PLC and gives you borrowing power for up to 80 per cent of your home’s appraised value. The costs may include legal and appraisal fees, and sometimes penalties.
Another option is to borrow extra funds for renovations when taking out a new mortgage or making a new home purchase.
There are dozens of ways that a renovation can be financed and managed effectively. Start by discussing your needs with an objective financial advisor and choose a solution that fits your budget and need for flexibility.