Refinance for renovation, use 401k? HELOC? Both?

Question

We've decided to remodel our kitchen.

For the sake of round numbers, assume I have about 20K in the emergency fund/savings right now. 20K in a stock portfolio, and a MUCH larger amount in the retirement funds (Traditional IRA and 401K), due to being a steadfast contributor, generous matching from multiple employers, and the fact that the market has just finished a strong recovery. I am 43.

As a risk averse person, I am reluctant to tap into the emergency fund and drain it to pay for the 30K (approx) kitchen remodel.

Note: We have a 24K second mortgage on the house that has a high 7.625% rate. My plan is to pay that off now, as part of all of this, but that will take a chunk out of the emergency savings as well. The primary mortgage is 4.375, 23 years left on a 30 year fixed.

Our options include:

1. Refinance the entire mortgage into something like a 30 year fixed at 4.375, same rate as we have now, but it lumps the mortgage into a single mortgage and gets rid of the hefty 6.725 rate while preserving cash flow. Closing costs would be about $5000. So this isn't ideal.

2. Refinance to a more aggressive loan, like a 15 year loan at 3.75. But then forced to pay a higher monthly amount to the mortgage. Also, 5K in closing costs.

3. Take advantage of something like Sikorsky Credit Unions "Advantage" 12 year mortgage, at 3.09%. Pros: $700 all in closing costs. 12 year target for mortgage payoff, savings for us of $130K on interest from the current setup. Downside: $700 a month higher payment, even if times get tough. This could be challenging for cash flow.

4. Borrow from 401K with currently employer. Pros: Borrowing own money, paying self back with interest. Leaves current liquid assets untouched for safety. Cons: Market opportunity (although when the market is very high, like now, it seems a better time to take this risk than when the market is starting a 2009-2018 type recovery). Obviously if over the next 5 years the market sits flat or has another large dip for a few years, it would have been a smart move, but it's hard to tell. Also, current employer has told me I have nothing to worry about with job security. Plus I would have a 3-4 month severance if I did lose my job, and the emergency assets intact.

5. Pay off the current 24K HELOC at 7.625 with emergency savings, and immediately open a new one. Sikosrky right now has a deal for a 2.99 HELOC through June of 2019, after which it's prime - .25 or something like that. Interest only.

Edit: Forgot to add #6. Pay off the HELOC 24K, and just keep the 4.375 23 year remaining mortgage, but make extra payments of $600 a month similar to the 12 year 3.09 option that is forced. In case times get tough. Downside to this is that even if I make the same payments via extra payment, you still end up paying something like 40K more over the 12 years due to the difference in rates, but you gain the safety of a lower required payment in a major recession or job situation.

I'm considering doing #3 and #4 together. But would love for people to show me if my number crunching has been in error. Could also split this up a bit, 20K from 401K, rest from a new HELOC, etc.

Last: Please avoid the temptation to advise us NOT to do the kitchen and instead payoff certain mortgages or debts instead, because we have thought for 12 years about this and decided it's happening for sure, for quality of life reasons, and do to a number of issues with the kitchen (literally rotting cabinets, warped counters, hardwood floors are shot, etc). We spend most of our time in the kitchen/dining/living room great room and we want to remodel it finally. We plan to be here for at least 6-10 years, or for good.

Answer 1

I would pay off the HELOC today. The "safety" of having $24K in cash/stock is costing you $150 a month in interest. You still can have $16K in liquid savings to handle most all emergencies.

From there, then you can decide which is more important - having a larger cash emergency fund or remodeling your kitchen. The kitchen is something you've wanted for a long time, which is understandable, but you should do it objectively and knowing what it's costing you.

I would not borrow from the 401(k). The "interest" you pay is the earnings that you will not get. You could hope that the market does not earn even half of its average of 10% over the next several years, but the odds are against you. You also seem pretty secure about your job, but things do change, and if you have a better opportunity you may feel locked in because of the loan.

To see if a refinance/extension of your mortgage is worth it, you need to know how much you'll be saving in interest versus the refinancing cost. With a $350,000 mortgage, dropping to a 15-year note and adding $30k would reduce your interest by $1056/year, which would be a 5-year payoff, but your payment would increase by $800/month, so you'd be better off just paying the $800 to the remodel and getting it paid off in a little over 3 years.

If you can afford to drop to a 12-year mortgage, then that would be a huge savings in interest in the long run, but I suspect it would be a big strain on cash flow, especially if you want to start replenishing your emergency fund.

The next cheapest option in terms of interest savings is going to be to using the new HELOC to finance the kitchen remodel. Then work like mad to get it paid off as quickly as possible. The new loan is going to cost you about $75/month in interest.

You might also consider doing the renovation in phases, using as much of your cash flow as possible, reducing your new debt and the amount spent on interest. save up for a few months, tackle one project with what you've saved, and work through the remodel at whatever pace you're comfortable with.