A Naive $8000 question.

[Enuff2Eat]

Hi All,

I have to pay a contractor $8000 to rehab an investment property in a couple week. Right now, i got about 25k in the saving account but my HELOC line is available upto 100k. should i pay him out of my saving or the HELOC? Heloc rate is at 8% but it is tax-write off.

thanks

enuff

[Marshac]

0% 12mo balance transfer check from a credit card

[ESRBob]

Enuff,

(Aside from a zero percent loan from a credit card -- probably your best choice!)

I think the math is pretty simple

Interest on HLOC = .08
Interest on MM assume = .04
Tax rate assume = 40%, in other words your state and local taxes combined will be 40% at the margin.
After Tax return on your MM account: .04*.6 = .024 or 2.4%

You can fill in any of these numbers with the right numbers for your case and see where the math leads you.

Formula (happy to have the engineers improve on this):

Interest paid * (1-marginal tax rate) = effective interest cost

.08 * (1-.4) = effective interest cost
.08 * .6 = 0.048 or 4.8% effective after tax interest cost of HLOC

Compare this to interest foregone by using the money in your money market account, again looking at after tax return on your MM (or comparable bond short term bond fund) :

4% x (1-.4) = 4% x .6 = 2.4%

You would be giving up 2.4% annually by taking the money from your MM account.

So my way of looking at this is: if I am earning anything under 4.8% on my MM account, i lose less by using my own money instead of borrowing it. If I can earn more than 4.8% on my MM, I am better off keeping the money in there and borrowing.

In this example, use your own money instead of borrowing as your effective cost is 2.4% instead of 4.8% For the 8k then you save $192 per year.

Some would argue though that you should look at the return your 8k would earn in a diversified portfolio or a riskier portfolio -- maybe close to 8 or 9%. But since the debt is real and non-ambiguous, you should compare the return to a real and non-ambiguous fixed income investment, such as Money Market or Short Term bond fund to be sure you are comparing apples and apples.

[cute fuzzy bunny]

Other answer, sort of a mod on justins "idea"...see if the contractor will order the materials they need and let you charge it to a home depot or lowes charge card, whichever is near you and has a one year no-pay/no-interest for 1 year deal going on for customers...

I put all the materials for my wifes house on one and it sat there happily until i sold the house.