It took years to plan the demise of your avocado and gold kitchen. Now, just as the contractor is preparing the final bid, you start to worry.

 

The value of your stock portfolio has declined by 30 percent and your prospects for a big raise this year are slim. Should you still spend part of your savings on the new kitchen or think about taking out a loan?

 

The best approach is to look carefully at your financial picture. This advice should be followed in any economic climate, but it is particularly important now, as stock market declines and unemployment rates hit closer to home.

 

What Are Your Goals?

First, look at your overall financial goals. How close are you to retirement and meeting your retirement objectives? Is your portfolio still on track to deliver the results you want?

 

Then consider how the improvements will affect the value of your house. Even in the slowest of markets, modest kitchen and bathroom projects typically produce the best returns.

 

If you finance your remodeling project with money from savings, look at the rate you are receiving and how much money will be left. If you are earning less than two percent interest from a bank's savings account and you have another nest egg for retirement, then tapping into your savings is still a viable option. In the same scenario, if you are taking money from a mutual fund, weigh any capital gains taxes against the cost of interest on a home equity loan.

 

What About Retirement Funds?

If you had planned to take money from your core retirement funds, then proceed with caution. Since many investments tied to the stock market have declined in value, you may be compounding the problem by taking another large chunk out of your retirement funds.

 

Plus, you will lose years of potential interest gains by removing the money and spending it on a new kitchen. There also might be taxes or penalties for early withdrawals.

 

Before tapping into these funds, consider how it will affect your ability to retire at a certain age or live a certain lifestyle. "For a younger person or couple who is also trying to accrue assets for retirement and other things down the road, how does that affect their ability to get to where they want to go?" asks Kyra Morris, a certified financial planner and owner of Morris Financial Concepts in Charleston, S.C. "A lot of people are scared that they're not going to be able to retire when they thought they would."

 

Consider Refinancing

A better alternative for some home owners is to refinance their home or take out a home equity loan. Someone who is spending $40,000 on a new kitchen, for example, can refinance at less than seven percent and stretch the loan out as part of their mortgage for 15, 20 or 30 years, said Dee Lee, a certified financial planner and owner of Harvard Financial Educators in Harvard, MA.

 

"Go to the trouble of refinancing," Lee said. "It's not like buying a car which is going to depreciate. You're adding value to the home."

 

The longer mortgage term gives home owners lower scheduled payments, which can add flexibility in the event of a job loss or other financial problems. Otherwise, they should consider paying an extra amount each month toward the principal to help pay off the loan sooner, Lee said. With a home equity loan, the loan rate is around eight percent and the term typically is for three to five years.

 

Avoid Using Your 401(k)

Another option that some home owners consider is to borrow from an employer's 401(k) retirement plan.  While that type of loan has benefits, it is not advisable in today's economy, Lee said.

 

If you leave your company before the loan is paid off, you have to repay the remaining balance within a short time period. Otherwise, the loan will be considered a taxable withdrawal and, if you are younger than 59 1/2, it will be subject to a 10 percent withdrawal penalty.

 

"Let's say you lose your job," she said. "The loan is due in 30 to 60 days and now you have a house under construction, you don't have a job and you owe $40,000 for your new kitchen."

 

There are many options to consider when deciding how to pay for your remodeling project. The key is to define your objectives and take a close look at your finances.

 

In many cases, those who are concerned about having enough money for retirement would fare better with loans instead of taking money from savings. "If you've got bonds out there at 7 percent, why go cash in the bonds when you can't replace that bond rate?" Morris said.

 

Instead, let your retirement funds grow again as the market recovers. "The probability that within the next three to five years the market will turn around is pretty high," she said.