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Possibly a misuse of the term, in its strict financial sense. Anyhow…
For decades I’ve heard about the value or use of leverage. It’s most easily recognized in our homes, often bought with a small down payment and a big loan, so that even minor increases in home value in early years create impression of a big return on our actual expenditure.
Yet last year, when I took on several major home “repairs” (a loose term for work that included demolishing and rebuilding a decrepit garage), I couldn’t bring myself to take out a home equity or personal loan. Instead, I spent down “emergency” cash and withdrew longtime holdings from a taxable brokerage account to cover construction costs. Looking at my accounts now, some months after final payments and inspections, there’s substantial but slow rebounding. It’s going to take a while to recover, maybe a few years of financial indigestion.
Yet I sleep better if I’m not in debt. Also, I felt as if (true or not) with the market near/at a peak, things could downswing into bear category reductions, maybe lasting a few years. So I might as well sell at the top, capture some gains, put them to work.
It seems to me that the Humble Dollar community values more a family’s steady if smaller gains rather than engaging in bold leverage plays. Am I right about this?
Or am I a chump to spend real money in hand if possible for major rehabs, instead of borrowing? It’s more than a moot question, as follow-on expenses are sure to arise, maybe roof or HVAC or another unforeseeable surprise.
I don’t think you’re a chump at all. I actually agree with your strategy.
Leverage has its place, but so does peace of mind. Sometimes the spreadsheet says one thing, but your gut and your sleep say something else. At this stage of life, that matters.
Could you have borrowed the money and maybe come out ahead if the market kept climbing? Sure. But real life is not a clean math problem. Markets fall. Rates matter. Repairs run over budget. And roofs, HVAC systems, and other surprises do not wait for the perfect financial moment.
To me, you used money for its purpose. You had a real need, you had resources available, and you avoided adding another monthly obligation. That is not being foolish. That is being disciplined.
I also think “emergency fund” can be too narrowly defined. A major home repair that protects the safety, function, and value of your home sounds like a legitimate use of reserve money to me.
The downside is real. Rebuilding cash takes time, and watching accounts recover can feel uncomfortable. But I would rather rebuild savings than carry debt I didn’t want.
So no, I don’t think you were wrong. You chose stability over leverage, peace of mind over optimization, and steady progress over another payment.
Sometimes the best financial decision is not the one that looks perfect on paper. It is the one that lets you sleep at night.
~ Jeff
I’m 100% with you on this one. One key financial aim that we have always had is to pay down debt as quickly as we can, and avoid taking on any new debt. And it worked well for us.
I get it that the math says that taking on debt can lead to a better financial result, rather than dipping into investments. But we all need to sleep at night, and debt can interrupt your sleep!
With regards emergency funds, we have never had something we might think of as an emergency account. But we have always had some way to access funds if required. Sometimes that was by drawing down on investments, which ran this risk of selling at a loss if our timing was bad. But the benefits of being invested over the long term have far outweighed the downside of selling a portion of an investment at a loss (which has happened).
“Yet I sleep better if…”. Its beyond my scope of competence to say what you “should” have done, from a financial point of view. In my opinion, you were wise to listen to your inner voice, because as the old saying goes: “the best plan is the one that you can live with”. And one can always modify or tweak that plan over time if warranted. Good article, Catherine.
These can kind of be brain-twisters, can’t they? There are so many different ways to look at this, and it really depends on one’s own financial big-picture, how they feel about debt, and so forth.
For instance, unlike many (most?) people here, I’m OK with having a mortgage in our old age because we’re fortunate enough to have substantial guaranteed income (pensions and soon SS). If we were counting exclusively on withdrawals from our retirement portfolio to pay our bills, I’d see this very differently and we would have made different choices over the past 10 years. We don’t have any other debt, but I’m OK with that one.
I’ve long been a fan of having a HELOC open and available whether I plan to tap it or not. It just gives me peace of mind knowing that source of ready funds is available so that I don’t have to get into my IRA and pay taxes on the withdrawal.
I also like having at least some cash that’s easily accessible (online savings accounts). When you have young adult children, things can happen–job/housing loss, car trouble, an accident. Knowing you can get money quickly if there’s an emergency helps with the anxiety level.
We spent a lot of our adult lives, really until well into our 40s, being cash-poor and house-rich (well, sort of). Our “emergency fund” consisted of “credit cards” and “my IRA.” I never liked it and wouldn’t want to go back to that.
Thanks for raising such an interesting topic, Catherine!
thanks for your thoughtful comments.
we set up a HELOC decades ago as we were doing projects on our then new-to-us house. closed it about when we paid off.
many people’s overall net worth is house heavy due to housing’s relative illiquidity. not all bad.
I can recall three times in my life when I used retirement money to meet unexpected expenses. I regret them all.
now, though, as the age for RMDs creeps up on me, the retirement account has become something to rotate into use after careful consideration.
Great topic Catherine. To those suggesting paying for the remodel with debt–perhaps with a home equity line-of-credit–would Catherine, as a retiree, have any challenge qualifying for the HELOC?
She can get a HELOC.
‘A retired person can get a HELOC. Lenders cannot deny a loan simply because your income is from a non-traditional source. However, instead of looking at a traditional paycheck, they will focus heavily on your overall financial stability, credit, and home equity to ensure you can afford the payments. [1, 2, 3]
Key Qualification Requirements
Because you are retired, lenders will evaluate your application using the following criteria:
Thanks for your comments and the list of what gets looked at for retirees seeking a HELOC. Useful for more than just me, though I seem to recollect one good time to set up a HELOC is shortly before retirement.t
That’s a great question. I think if one has locked-in income (pension, SS, maybe annuity?), it’s the same as applying when you have wages. But if you’re counting on regular withdrawals from your portfolio, that can be tougher.
I’m pretty sure I could set one up. Not so sure I would prevent myself from rationalizing its use when other choices would be better. The loss of a level headed spouse who felt different than me on many spending questions has made me extra cautious, I guess.
Excellent article. You made the right decision. I do the same thing every time I buy a car. Just like you I hate debt, hate monthly payments, and if I put the money in a stock or index, my luck I will lose more money than to just pay it off. Well done as we both like to sleep at night.
thanks for your comment. I especially like this line:
“…if I put the money in a stock or index, my luck I will lose more money than to just pay it off.”
I recognize that losses or gains in a financial account are not real unless one (buys or) sells. I’m pretty good at not panicking and selling when markets decline and I also am conscientious about rebalancing. Intellectually I know that my non-Roth IRA balances are only partly mine, with the government ready to take its share of every dollar.
I’m also trying to avoid the early retirement hedonic treadmill. I’d like to continue to live the moderately comfortable life I had while working, no more.
That said, with a 95-year-old house calling out, and not wanting to leave the kids a teardown in waiting, and with the markets at something close to an all time high, didn’t have any gamble in taking the wins now rather than hoping the markets continue rising for the near future when I will be compelled to withdraw RMDs whether or not my accounts have dropped with a correction.
I have a question. What exactly is an emergency that would require a large cash payment immediately? I’m serious. For a person with reasonably good finances, I can’t think of one that couldn’t be handled in a way other than writing a check.
this is an excellent question! the funds needed were relative small when I was a young adult, larger now.
I think a recent study used the idea of a sudden $500 expense (a plumbing problem, for example). Many could not meet that expense.
Myself, I might consider the cost of a roof repair or an air conditioner that fails.
there are lots of ways other than writing a check, yes. I suppose my debt free strategy derives in no small part from my mother’s family stuggles during the depression.
Ouch! Faced with similar renovation needs, we chose to take out a small LOC, which we then worked hard to pay off as quickly as possible. I don’t like debt any better than you appear to, but I was always mindful that having enough ready cash in the event of a sudden emergency was critical. The important issue is recognizing that debt is a tool and should be handled properly at all times. When we are young, buying a house or car is likely not possible without taking on debt. Credit card debt, however, is mostly a choice and a privilege that should not be abused.
Catherine it appears you are a good financial steward making thoughtful decisions. If this approach works well for you, stick with it.
When torn between two choices, I think one option to explore is to do both. It’s like compromise in legislation: neither side feels good, but both sides get something they want. Taking both a smaller loan and drawing down a smaller amount of taxable assets would have given you what you needed but not impacted either bucket as much. Oh, the financial psychology we must endure!
thanks for your comment. good point that it’s rarely an all-or-nothing situation.
I don’t like debt or keeping lots of cash. If you have a taxable brokerage account you can convert it to a margin account which allows you to borrow money from the broker in an emergency. A bonus is that you can learn about hypothecation agreements.
I’m sure you are aware of the riskS of a margin loan. If for some reason the market drops and you go below margin requirements, you have to add money to the account, or sell stocks to pay it down. Just an FYI
I actually considered this, and talked with a couple people at a firm where I have a stock account. It’s on the table if I have another such need (hoping not! hoping for more average sized maintenance from this point forward.)
I’m sure you are aware of the risk of a margin loan. If for some reason the market drops and you go below margin requirements, you have to add money to the account, or sell stocks to pay it down. Just an FYI
HECM
Reverse Mortgages: How to use Reverse Mortgages to Secure Your Retirement (The Retirement Researcher Guide Series)
By Dr. Wade Pfau
They are no longer a late-night TV nightmare
Depending on your age, assets, home value, mortgage, etc. you might just want to let your appreciating home “pay for itself”.
Wade Pfau’s work is great. For the right person, at the right age, a reverse mortgage can be a good choice.
though, not completely convinced (yet) they have shed a once deserved reputation as “a late-night TV nightmare”.
Thanks for your comment.
We were in a similar situation where we considered a bridge loan through HELOC while fixing up a new home as we were selling our old. It gave us cash for the improvement while we waited for the profit from the prior home. Our cash on hand funds were being spent down (I don’t call the emergency funds in our situation) making me feel uncomfortable, so in the end my biggest complaint was the slowness of the bank’s approval process and the volume of paperwork required from a couple with no debt and long standing positive financial history. The HELOC application seemed a total waste of time and energy in this case.
“volume of paperwork” makes my hair stand on end. ditto the slow approval process.
Interesting conundrum. Like you I prefer no debt. But I agree with Dick and Mark and I think I would have preserved the emergency fund.
Like David, we no longer have an emergency fund as such. But we do have access to ready cash. I wouldn’t feel comfortable having this too low. Yes, a loan may be possible, but that’s a maybe and loans can take time. Or we might be able to sell assets, but they may be down and those proceeds can still take a couple of days to be available, and who knows the nature of the emergency. Meanwhile readily available cash is certain.
Thank you Michael for your comment. One thing this work has helped me consider is the difference between “cash” and “ready cash”. Similarly, cash in a taxable account or bank account vs. stable value contracts in a retirement account.
when I was working I didn’t have much time to think about asset classes. luckily I’ve developed some interest in financial management as a retiree.
Completely agree. We have a sizable allocation in a 401(k) stable value fund but that’s definitely not what I consider ready cash.
I’m 100% debt-free and plan to stay that way, so I understand your reasoning. That said, I wouldn’t have been comfortable draining all my liquidity for a renovation project — to me, being cash-poor and being in debt carry roughly the same stress. Debt creates stress through fixed monthly obligations; zero liquidity creates stress through vulnerability to shocks. Both states rob you of control. If I’d been in your position, I’d have first secured a HELOC as a safety net. (not to use, just to have in reserve) before spending down my cash to stay debt-free.
thanks for your comment.
I totally agree with your point about zero liquidity creating stress.
my personal exploration of my own “best” liquidity revolves around changing needs. more to Bill Bengen’s suggestion of somewhere between 1% and 5% depending.that’s a huge range!
I had a lot more liquid assets when I had
twins in college and was paying tuition bills regularly and per plan. now, the last few years’ combined inflation of somewhere around 20% has me rethinking how much “cash” is the right amount for me.
overall, regarding money and stress, I’m surprised at how some years I am sanguine and other years less so, depending on my situation and that of my family. Things change more often than my younger self might have imagined.
👍👍👍👍
I suspect part of the discomfort is that this wasn’t clearly an emergency, nor was it clearly discretionary. It fell into that messy middle ground where reasonable people could justify either spending cash or borrowing.
The other thing that struck me is that avoiding debt and avoiding regret aren’t necessarily the same thing. You may sleep better without the loan, yet still feel a twinge as you watch the accounts slowly recover. Sometimes the financially optimal choice and the psychologically satisfying choice aren’t the same.
Thanks for this characterization. Yes, the “messy middle” which is where I think I am living most of the time! I agree that financially optimal differs. And I’m pretty sure if I had been raised in a household where borrowing against one’s assets rather than selling them was the normal strategy, that’s what I would have been more comfortable doing. Instead, I grew up in the land of layaway and holiday savings accounts. It does affect one’s perspective of credit.
Catherine, I feel the same way you do, averse to debt now that our house is paid off. I am saving right now to pay cash for a new (to us) car. We proactively replaced our 20 y/o refrigerator this week before it failed. With cash. Chris
We had paid off our mortgage for several years before we decided to move to our retirement home. Couldn’t find anything to buy so built. We had to take out a measly 50K mortgage to build the home, then ASAP switched to HELOC.
It was hard on me to accept having a debt after finally having no mortgage. Three years later we received an inheritance from my parents and the first thing we did was pay off the loan. I was glad that we did not know we were receiving the inheritance as it resulted in us building a more basic house that we could afford at the time. The only improvement since has been upgrading to quartz countertops to replace the Formica ones, and a backsplash which I told my wife to consider a final gift from my parents.
When we build the three season porch I plan on using money in our brokerage account to pay for a large portion of the cost. If we need more will take out a HELOC to cover the balance so we don’t spike our income from a tax and IRMAA standpoint.
I don’t particularly like debt, but when 1st mortgages were 2.125%, I couldn’t resist. Our house will be paid off when we’re 90. I feel pretty confident that my return on assets will far outweigh 2% in the meantime. I certainly don’t mind a mortgage!
Very similar to my own life, though I bought my last new (to us) car with a 3-year loan that I paid off over 9 months. Weird that while I had that loan my credit score went up (because periodic payments is an element of the credit score algorithms I guess.). And I just replaced my 20 year old refrigerator. Yes, cash. I don’t think the basic refrigerator is built to last, at least that’s what people who sell and fix them say. This time I got one with fewer bells and whistles, hoping to get another 20-year appliance run.
I don’t like debt, I don’t have any debt. I paid cash for my car and three kitchen and bathroom renovations.
However, I would never use emergency savings or sell brokerage investments and incur more taxes. The exception perhaps a big emergency.
I think you put yourself at risk unnecessarily. You could have taken a loan, maybe made payments from investment earnings or at least you could have paid off the loans with investment funds later if and when in the future it became a problem paying the loans.
Thanks for your comments.
I’m still getting the hang of being a retired person. And as a widow and a single parent of three young adults, I still spend a fair amount on not-so-typical expenses for a retiree.
That said, I find myself agreeing with many of the ideas in Bill Perkins’ book Die With Zero, and have been trying to spend a bit more in ways that I think will help me and my kids. I also wanted to do more than simply rebalance my assets after the last few years’ rise in the stock market. Why have I been saving money all my life if not to spend some from time to time on things that matter to me? In terms of the house, I want it easy for the kids to sell if I should exit abruptly (as did my spouse), not have them dealing with a rundown place stuffed with 35 years of papers and items of personal interest to the dear departed and nobody else (ergo, the slow but semi-steady emptying of the house’s contents.)
Yes, there are taxes to pay on withdrawals, and I’m not especially looking forward to what will seem to me excess withdrawals with the tax bills to match once I hit RMD age. But I rarely begrudge my tax bill, and am grateful that I have income and resources to pay what other people have determined is my “fair share”. Back in the day, I went to public schools and a public university. My living expenses were government paid for three years when I was in service. So I’ve been on the receiving end, too. Governments do things like education and social services and Medicare/Medicaid for millions who cannot pay for those things themselves.
Your point on spending from so-called emergency funds is important. Again, each person’s situation is different and I’ve read different suggestions regarding how much to set aside in case of emergency, While my project spending has reduced my emergency funds for a spell, I still have access to credit along with my reduced stash of ready cash and it’s hard for even me to imagine an emergency bigger than those two sources. So concerns for an ordinary size emergency don’t bother me much. (caveat being that it’s possible between me and youngsters we could have a slew of emergencies.)
Lastly, and it’s something I haven’t mentioned above, is the question of liquid assets (bank accounts mostly and a few other things). What proportion of my assets should I keep in ready cash? Again, answers vary based on a person’s situation. For me, periodic payments cover my ongoing fixed expenses, grateful for that. And in a recent interview regarding his new book A Richer Retirement, Bill Bengen suggested that most people need no more than 5% cash, while noting that he himself keeps only 1% in cash, mainly since the more cash a person has, the bigger drag on a portfolio, and cash is clobbered if we have an inflationary stretch. Just one way to look at the question of cash.
Again, thanks for your comments, thought provoking as is typical.
I likewise have a strong psychological aversion to debt. But isn’t there an additional factor? If you took out the loan, that would free up the funds you’d otherwise use to continue to be invested. You’d be betting that they’d earn more than you’re paying on the loan interest. With the market currently at such lofty heights, I’d be uncomfortable making that bet.
Jonathan has written that paying down a mortgage is like getting a guaranteed return of the mortgage’s interest rate. In most cases, that’s pretty hard to beat, not to mention a good portfolio diversifier.
I agree with much of your post, but am not paying off my mortgage early due to it having just a 3.25% interest rate. Investing provides a higher rate of return. Our pensions more than cover our expenses. Not spending down our savings to pay off the mortgage leaves us plenty of liquid assets to use for home remodels or other unforeseen expenses.
The last mortgage we had was a 7% 15-year. By the time the rates hit those lows we were out of debt.
I guess rates aren’t quite back to the level of my last mortgage, about 5.5% for a 15-year note. That would be less than I would earn in the market but more than I would get on a treasury note. It’s an apples to oranges comparison, in terms of assets.
Agreed. I explained in a past post, that rates were in the 3s when we contracted to build our house. By the time the project was complete, rates had gone to 7%. That made our decision to remain mortgage free easy.
Makes complete sense, Dan!
Catherine, I don’t know about everyone else around here, but after engaging in some agonizing inner turmoil, I always end up in your camp.
We moved into our new home 2.5 years ago. During the construction phase we met the periodic ‘draws’ by hitting our emergency funds, brokerage account, non-taxable reimbursements from my Health Savings Account, and finally IRA distributions in order to avoid a mortgage.
Was that the right decision? The market has been crazy good, but the new home has gone up in value as well. Maybe I’m afraid to do the math, or maybe I just don’t care. Loan free is the way to be.
I share your perspective. And though home improvements don’t necessarily pay off at the same rate as fund growth, it’s not like I was spending money wily-nily. Most of the expense has created a house that looks much better, and would be easy to sell at current market price if I (or my estate) had to do so.
But what if during that time or shortly after you ran into a cash necessary emergency?
I imagine a loan would be very possible. No crisis. It’s nice to stay debt free, but reasonable borrowing works too. We’ve done both.
I still had multiple sources to draw from. We were in no danger of being caught short.
When you mentioned emergency fund, I guess I interpret that differently as they only money available for unplanned spending.
I understand. Your comment along with David’s below, has me thinking that the term ‘emergency fund’ means different things to different people. A young adult who struggles to raise a family, buy a house, and save a little for retirement would be wise to have a separate account for the unplanned expense.
A retiree with a five figure checking account balance could consider that to be sufficient to cover emergencies.
In a sense, maintaining a separate emergency pot of cash is sort of like living with a budget; neither one may be necessary.
But then some people like me really don’t have an emergency fund, we just have 1-2 years of cash (federal money market) in our portfolio and 8 years in bonds, mostly short term. We really consider all of our liquid assets as an “emergency fund”.
thanks for your comment.
I like the idea of one or two (or more) years of cash.
seems like a straightforward calculation and might be. yet my cash needs have varied year to year with three college-aged kids. I have a fair amount of secure income and so focus my one or two (or more) years calculation on the somewhat discretionary expenses that exceed my fixed and covered expenses. not sure if others calculate that similarly. maybe my strategy misses the mark somewhat due to variabily associated
with a moderate amount of ongoing if declining support for young adults.