When Does a Home Remodel Make Financial Sense?

Dear Carrie,

We're in our late 30s and bought our house three years ago. After spending so much time at home this past year, there are things we'd like to enhance, but we're debating putting money into a remodel at this time. Your thoughts?

Dear Reader,

There's nothing like being home 24/7 to bring out the flaws in any space. No matter how much you love your house, there always seems to be something to improve. And this past year, as more people had to make their kitchen do double duty as an office or needed added space for kids stuck at home, the remodeling industry has seen a corresponding increase in business, according to the National Kitchen and Bath Association. 

But whether you're considering a minor upgrade, a major renovation or even an addition, it's never an easy decision. There's what you can afford, of course. Then there's the time and hassle. But there's also an emotional side.

Your home isn't just a practical space to put your stuff. To some people, a home represents stability and comfort. To others, it's status or style. Many regard home improvement as an investment that will produce a return when they sell. For you, it may be all of the above.

But no matter how you look at it, your home is first and foremost where you live. There's a lot to consider, both practical and personal. So before you get serious about your plans here are some things to discuss and decide.

What do you need and why?

Let's start with the practical. Why do you want to enhance your space? More room to work? Better efficiency? Or is it to upgrade or modernize to create a different feeling? Interestingly, according to a 2019 National Association of Realtors (NAR) report, 32 percent of homeowners say the single most important result from remodeling is functionality and livability. Only 16 percent rate beauty and aesthetics as most important.

Just how much of a remodel will it take to give you the functionality you want? Adding a room is a big financial commitment. A cosmetic remodel is usually far less costly, but may not give you what you need. If you're going to spend the money and time, make sure you’re going to get the result you want.

How will the remodel make you feel?

Have you heard of the Joy Score? That's how the NAR has homeowners rate their satisfaction with a remodel.

In the report I mentioned above, a kitchen upgrade was rated a 9.7 on a 10-point scale. Converting a basement to a living space got a 9.5, while a simple closet renovation got a Joy Score of 10. On top of the utilitarian considerations, will your remodel make you happier to be home?

What will it cost?

Here's where emotion has to take a back seat to facts and figures. Remodeling costs vary depending on where you live. For instance, the average cost for a kitchen remodel in the U.S. is around $23,000—but in California it's upwards of $80,000. You might want to check out an online remodeling calculator that offers estimates by zip code to get an idea of what you may be in for—which can be eye opening!

A word to the wise: It's estimated that nearly half of home renovations go over budget. So even if something sounds affordable, consider adding an additional 20 percent or so for project overruns.

How will you pay for it?

While you may be able to cover certain things like appliances and materials from savings or put them on a credit card you can pay off quickly, what are your options for covering larger expenses?

I sometimes get asked about the wisdom of tapping into a retirement account either as an early withdrawal or a 401(k) loan. To me, neither is a good choice. First and foremost, when you take money from a retirement account in any form, you're jeopardizing your future. But beyond that, there are other red flags to each.

An early withdrawal subjects you to a 10 percent penalty as well as ordinary income taxes. And the withdrawal could actually bump you into a higher tax bracket. While the rationale for a 401(k) loan is that it's your money, interest rates are fairly low, and you pay the interest to yourself, there's the risk you won't be able to pay it back on time, which can also generate taxes and penalties.

Since you own your home, you might consider a home equity line of credit (HELOC). HELOCs are generally low-interest, and you only pay interest on what you actually borrow. Plus, under existing tax laws, the interest may still be tax deductible if your total home-secured debt is $750,000 or less and you’re using it to improve your home.

A cash-out refinance is another option if you have enough home equity. With this type of loan you borrow more than the principal balance of your existing mortgage, use the proceeds to pay off that mortgage, and put the extra money toward your remodel. However, this may be a more expensive option than a HELOC.

Don't get in over your head

While today's low interest rates can make borrowing against home equity attractive, be sure to calculate your debt load before you get in too deep. As a general rule, no more than 28 percent of your pretax income should go toward home debt and no more than 36 percent toward all debt.

You may love your remodel now, but if you overextend, paying for it could cause financial pain later on. Even more painful is if it keeps you from saving for other important goals. 

Be realistic about getting your money back

If you regard a remodel as an investment, be realistic about potential return. Again, the NAR offers some insights. For instance, you might be able to fully recover the cost of refinishing hardwood floors, while a bedroom renovation might return far less. Unless you're planning on selling right away, return on your money is probably the least important consideration.

I can't tell you whether it makes sense for you to remodel, but I can encourage you to carefully consider both the financial and emotional issues. It may sound simplistic, but if your remodel increases your everyday enjoyment of your home as well as its functionality, you'll feel better about the cost.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.