# To borrow or not to borrow



## Plutos (Nov 28, 2010)

Dear forum users,

I wanted to seek your opinion about the following:

My parents are planing to renovate a family home. The house needs a lot of work and the estimate for renovation is about $25000 (new roof, new boiler, new everything). They have cash that they could pay this with, but they also have line of credit that they could draw from (at 6% interest). Some have said that its better to use "bank's money" rather than one's own money, so they are thinking about borrowing. I just dont see how it is productive to pay interest to the bank when you have free cash available.

If you were in this situation, would you pay cash (and then refill your own savings) or would you borrow and slowly pay down the LOC?

Thanks a lot, as always!

Plutos


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## MoneyGal (Apr 24, 2009)

The "use the bank's money!" line is a "clever" rationalization which has been borrowed (heh) from the investment and business world. When you have deductible interest expenses (you are borrowing for an investment property or business loan), of course it makes sense to "use the bank's money!" 

When you are personally responsible for the interest and there's no tax deduction, and/or you are paying for a personal expense with purely personal benefit, you should pay with cash if you have it. I cannot see how the argument to "use the bank's money!" is in any way applicable here. 

Of course, one implication is that if they use up their emergency money, and then they have (another) emergency (depending on how you define "replacing a boiler"), then they may have to borrow to finance the second emergency. But by this logic we should have ever-growing piles of idle cash available at all times in perpetuity, and that makes little sense, too. 

Your instincts are good. You should always ask "why?" (or the classic _cuo bono?_ -- "who benefits?" in Latin) when confronted with a financial decision. Who benefits if your parents pay interest? The bank. Do your parents also benefit? I don't think so.


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## OptsyEagle (Nov 29, 2009)

If the $25,000 was "all" their cash they might want to borrow "some" of the money, but if they have a little additional funds, it would be foolish to borrow the money. Let's face it. They will be using their own money anyways. They will either take their own money out of the banks vault and use it, or they will ask the bank to move their own money to the other side of the vault and borrow it. The latter case just gives the bank a very big interest spread from what your parents are being paid on their money and what interest they are paying to the bank, for their money.

I always hate borrowing my own money.


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## crazyjackcsa (Aug 8, 2010)

Numbers are a mystery, aren't they?

Let's say it takes 5 years to pay off the $25,000. That's around $485 a month, for 5 years. For a total cost of around $29,000.
So if they keep all that money, and set it aside in a GIC paying around 2.3% They will have $28,000 after 5 years. They then of course need to find an additional $485 a month in the budget. If they use the $25,000 they have to pay off the $25,000 they borrowed over the length of the 5 years, their earned interest would be significantly lower.

So, for the pleasure of using the "bank's money" it's going to cost an addition $1,000. That was awful nice of the bankers, wasn't it?


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## doctrine (Sep 30, 2011)

I thought houses were an investment. Can't you just have the house pay the $25k?


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## Rusty O'Toole (Feb 1, 2012)

2 rules I like to use. One is I don't like to borrow money to buy things that depreciate (like cars) but I don't mind going in debt for things that appreciate (like houses).

The other is, it only makes sense to borrow money instead of using your own, if you have some other investment that pays better. If you have some safe investment that pays 10% or 12% go ahead and borrow at 6% and keep the good investment. But these days this is practically impossible.

If the alternative is to give the bank your money for a GIC at 2 1/4% then borrow your own money back at 6% that's crazy. Use your money and save the interest.

Doctrine has a good point. A home equity line of credit should be available a lot cheaper than 6%. If you need to borrow money let the house pay for its own renovation.

In case this is not clear... I agree that you should spend your savings not borrow the money. But if you need to borrow the money a home equity line of credit is one of your cheapest options.


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## Square Root (Jan 30, 2010)

"let the house pay for it's own renovation"? Sounds like " use the bank's money"? I think I get your point but you do have a way with a phrase, Rusty.


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## Rusty O'Toole (Feb 1, 2012)

Square Root said:


> "let the house pay for it's own renovation"? Sounds like " use the bank's money"? I think I get your point but you do have a way with a phrase, Rusty.


That was Doctrine's line. He thought he was being a smartass when he said"I thought houses were an investment. Can't you just have the house pay the $25k?  "

In fact, you can get your house to pay for its own renovation by using your home equity line of credit.


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## Square Root (Jan 30, 2010)

Sorry about the quote. I think we all know that it's still your money however it's financed, right?


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## Rusty O'Toole (Feb 1, 2012)

Square Root said:


> Sorry about the quote. I think we all know that it's still your money however it's financed, right?


Not necessarily. It would be possible to finance the home improvements on a HELOC and never pay the money off. Eventually when the house is sold, it would be the house that paid it off. And if the $25000 in improvements increased the value of the house by more than $25000 not only would the house pay for its own improvements, it would give you a profit as well.

I'm not suggesting anyone do this but in theory one could do the home improvements and never pay for them out of one's own pocket.


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## MrMatt (Dec 21, 2011)

If I have the money, I just pay.

Why have money in one bank account earning nothing and paying to borrow "different" money to spend?

I don't see how it is "productive" to pay for money you don't really need.


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## Lephturn (Aug 31, 2009)

Rusty O'Toole said:


> Not necessarily. It would be possible to finance the home improvements on a HELOC and never pay the money off. Eventually when the house is sold, it would be the house that paid it off. And if the $25000 in improvements increased the value of the house by more than $25000 not only would the house pay for its own improvements, it would give you a profit as well.
> 
> I'm not suggesting anyone do this but in theory one could do the home improvements and never pay for them out of one's own pocket.


I think this just obfuscates the reality that you do pay it out of your own pocket - you just deferred payment of the costs to a time when you also had an income of cash. You also end up paying more in cost, as you pay the bank to finance the loan to defer payment until you sell the house. It still comes out of your pocket - you are just hiding the cash outflow by deferring it to take place at the same time as you receive a (you hope) greater cash inflow.


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## MoneyGal (Apr 24, 2009)

Don't confuse the issue with logic, Lephturn.


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## donald (Apr 18, 2011)

I get what rusty is saying-3 yrs ago i bought a lot for (30 k)private sale,used the ''vaule" of that lot to secure a construction loan for (203 k) lived in house for 26 payments against the construction loan/mortgage and then sold it private for 330k-I knocked my mortgage down to about 189k and made the difference,and no capital gains(tax)----maybe ''most'' of my roi on investment came from sweat equitiy but still i used the banks money and walked away with 125 ish k.It is logical.


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## Lephturn (Aug 31, 2009)

@donald

Your situation is different. If you had 200k in savings or GICs sitting in an account, you would have been better off to use that cash instead of taking out the construction loan. You didn't, so in your case you were getting the ability to build the house and invest the sweat equity which paid off. But if you'd had the cash you would have been better off to use the cash instead. 

I get Rusty's point - I simply don't like they way these loans are sold by obfuscating the true cost of the loan to somehow imply that it's "free" when it most certainly is not.


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## Square Root (Jan 30, 2010)

Actually, based on this way of thinking I don't have to pay for hardly anything- my dividends do.


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## Ethan (Aug 8, 2010)

Plutos said:


> Dear forum users,
> 
> I wanted to seek your opinion about the following:
> 
> ...


I think your parents should borrow the money. Since I'm such a nice guy, I'll be the financial intermediary and give them a better rate than their bank. Your parents will give me their $25,000, on which I'll pay them 2% interest. I'll then lend your parents $25,000 for the renovations, and I'll only charge them 5%. Tell them they can take their time to pay it off, as long as the interest payments come in monthly.


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## donald (Apr 18, 2011)

Lephturn-I did have a semi sizeable amt that i could of put towards the loan but did'nt.Why would ''one'' tie-up all there cash in one asset class(house,loan,ect)If it means not having any liquid(emergency funds aside).....plus with a house being built,i looked @ it like servicing the mth payments and after 2 yrs- sold(no capital gains)+ the loan is so heavy in the front(mortgage)you barley get anywhere in the first 2 yrs anyways(think i payed close to 38k,and was lucky to knock off 13/14k of principle @ the 5.5% back in 08(when i got it).-I thought it was ''smart" leverage. .....in my case.


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