Avoid the High Cost of Living Beyond Your Means
How much do you lose if your home is foreclosed?
What if your leased classy chassis is repossessed?
Finance only what will appreciate.
You loved Philosophy in college, so you majored in it—and now you can’t find a job to pay off the school loans! Should you borrow still more to go back and get a more marketable degree?
Traditional rule of thumb
Finance nothing besides career-motivated education and the house you live in (we’ll get to the car below). By career-motivated, I mean that if you’re going into debt for it, there had better be some expectation that it will enhance your career enough to pay for itself.
A traditional rule of thumb says that housing (mortgage, utilities, insurance, property taxes and association dues) should never exceed 35% of income (and 30% is better). That limit and a 20% down payment would have forestalled a lot of foreclosures when the housing bubble burst.
Keep to personal limitations
Another part of that traditional rule of thumb is that transportation expenses should never exceed 15-19% of income. That used to mean just don’t buy a new car more often than you can afford to.
These days it can also mean don’t buy certain brands or models unless the formula fits. How much car you can afford to buy should be limited by the amount of your cash and other assets that can readily be converted to cash, such as non-retirement investments and insurance for automobile collision and comprehensive (i.e. the amount they would pay you after your deductible).
Financing a car
I’m not saying you have to pay 100% cash for the car.
- You should definitely pay down at least as much as the car will depreciate when you drive it off the dealers’ lot.
- Go ahead and finance the rest of it, but be sure to insure it so that if something happens to it, you can cover the loss without financial hardship. Some of that may be what the insurance company will give you (the low trade-in value) minus your deductible.
Finance only what appreciates
This might sound rather complicated, but the point is not to finance things that will depreciate—only what will appreciate. (Remember that the housing market will recover and appreciate, and it will do so quicker than most cars unless they become classics.)
Never pay anything else in installments! Even at 0% interest, it complicates bookkeeping and there are too many loopholes to trip you up.