This Week's Q & A

Q: My husband and I are an older couple, in our mid-70s. We own our home, mortgage-free, and are planning to update our kitchen. The modernization, plus some structural changes we’re planning, will cost us approximately $20,000. We want to finance this in the best possible way, but aren’t sure whether that means paying cash, obtaining a mortgage, taking out an equity line of credit, or (as a friend suggested) obtaining a reverse equity mortgage. Can you give us some advice?

A: The answer to your question, as to most financial questions, depends on your economic situation. That’s largely a function of your current and projected income and assets and your current and projected financial needs. It sounds as if you would benefit from the advice of a financial counselor, who can review your financial profile in detail and recommend a strategy that matches your finances, as well as your personality and your near- and long-term financial goals. All are important factors in your personal economic equation.

Without knowing any of your financial details, I can’t give you the personal advice you need, but I can suggest some of the issues you probably will want to consider. I’m going to make a couple of assumptions based on the information you provided:

	Your income and credit would enable you to qualify for a loan
	You probably would prefer not to take on a lot of new debt at this stage if you can avoid it.

So what will happen if you withdraw $20,000 from your savings and pay cash for your home improvements? Does that leave you with sufficient assets to handle the expenses you reasonably can anticipate as well as the emergency expenditures you can’t predict?

Even if paying cash won’t make a noticeable dent in your financial cushion, you have to consider the “opportunity cost” involved. That’s the money you would lose by spending this $20,000 instead of investing it. These calculations can get quite fancy, but what you want to do is compare the cost of borrowing the money with the income you would derive from an investment you would be likely to make. You may find that it makes more sense to borrow some, if not all, of this money instead of financing the entire project with cash, but perhaps not. That’s one of the questions a good financial planner can help you answer.

A planner also can help you determine what kind of loan is best should you decide to pursue that option. Again, it is your finances and your financial needs that will dictate the choice. In a general sense, an equity line offers an element of flexibility – you can draw down funds gradually, rather than all at once, and you’ll pay interest only on the amount you actually tap. So you could establish a $20,000 equity line, but if your renovation project costs less than you anticipate (that’s never actually happened, as far as I know, but you might be due for a miracle) you would not have to pay interest on the unused balance.

The interest rate on your equity line probably will be adjustable (nice when rates are falling, but not so nice when they are rising, as they are now), and probably higher than the rate you would get on a mortgage. A mortgage will give you the option of a fixed or an adjustable rate and a longer term, which would mean smaller monthly payments, but potentially larger interest payments over the life of the loan.

Of the alternatives you mentioned, the reverse mortgage, almost without question, is the least desirable. The idea of a reverse loan is that you aren’t required to make any payments on it until the end of the specified term, at which point, it is assumed, the borrower (or the borrower’s heirs) will sell the house and repay the loan out of the proceeds. That sounds like a great deal, and it can be a useful strategy for some elder homeowners in some circumstances. But it is rarely a first choice for anyone. The problem with reverse loans – or at least, one of the problems with them -- is the cost.

Most of the programs you see advertised (and they are being hyped aggressively in some markets) are laden with up-front fees and ongoing expenses that can inflate the outstanding balance way beyond the original amount of the loan. Reverse loans are billed as a means of tapping the equity in your home, but in truth, they’re a means of eating your equity; quite literally, they can eat you out of house and home. If you have other financing options, and it appears that you do, they are bound to be less costly and probably better suited to your needs than a reverse loan.