If you’re renovating to upgrade your home, you’ll want to invest in amenities that you can enjoy long term. If you’re renovating to sell a home or improve an investment property, you’ll want to focus on minimizing costs while increasing value. The expense needs to be balanced against your goals.
Renovations are likely to increase a home’s value, but you should not always expect to make back its full costs. For example, if you plan to renovate a home now but sell it in 10 or 15 years, the renovations may be outdated, and you’re unlikely to get all of your money back.
Regardless of why you’re renovating, it’s important to keep spending within a range that fits your long-term financial goals. Start by talking with a financial adviser to determine how a renovation fits into your long-term financial plan and understand the best way to cover the costs.
Once you know what you can budget, plan to spend 90 percent of that on the renovations and save a 10 percent cushion for the unexpected. That way, if there is an issue or if you fall in love with higher-end fixtures — which often happens — you won’t be over budget. According to Houzz, nearly half of homeowners (46 percent) struggle to stay on budget during remodeling.
To cover renovation costs, there are a few options. In an ideal scenario, you would have savings to cover at least part of the project, but many homeowners don’t have enough cash to cover everything.
If you have a lot of liquidity in your assets, such as stocks and bonds, you may be able to pull from those assets. In this case, you would be putting your assets into an illiquid asset, so you would want to make sure that you have liquid assets remaining.
If you can use existing assets without interfering with your financial goals, you would save on interest that may come with taking out a loan, but you should also consider how much those assets would earn if they were invested. If you pay between 4 and 5 percent in interest on a loan, then you generally would be better off using assets to cover costs since you are likely to break even on growth in a standard, conservative portfolio.
If you don’t have savings or liquid assets, there are several financing options. Often, homeowners take out loans to cover renovations. And with interest rates at historically low rates, it’s a particularly good time to consider borrowing.
Home-equity lines of credit and home-equity loans allow you to borrow off your home if you have about 20 percent in home equity. If you do take out a loan, be sure that you don’t overborrow. You don’t want to overextend yourself by utilizing financing for renovations in a market that may turn.
Under the new tax code, home renovations themselves are not deductible, so, for example, you can’t just write off a new bathroom. However, the interest paid on home-equity loans or lines of credit is tax deductible, and there are deductions available for specific improvements.
If you make medically necessary renovations, such as installing entrance ramps or widening hallways, they may be deductible. Or if you are improving energy efficiency with new features such as solar panels, you can take advantage of energy tax credits.
The standard deduction is $12,000 for individuals and $24,000 for married couples filing jointly, so if you would be claiming less in total itemized deductions, you are better off taking the standard deduction. Consult with a tax adviser to determine if your renovations may be deductible and whether you should itemize them.
David Mount is a director with the Wise Investor Group at Baird in Reston.