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What Can I Really Afford to Pay?
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You think you are doing the right thing. You have something you want to purchase, but instead of throwing caution to the wind, you plan, and budget to make your purchase. You figured out how much you bring in, subtracted what is going out and being saved, and with what is left over, you set a limit on how much you can spend on your purchase. But did you really plan correctly? Can you really afford your new purchase, especially if it requires a monthly payment for years to come? I’m going to explain how you can make an informed and accurate decision on whether or not you can afford your next purchase.
We determine what our monthly budget allows, and fit the item into that payment amount. This method usually means a loan is involved and interest rates are added along with other costs not initially considered. We know these purchases most commonly as houses, cars and other lager items that are offered with financing. Usually these large items are beyond our ability to make a lump sum purchase.
When we have a large purchase to make, like a house or car, we look at what our budget will allow, and go shopping for something around that price range. For example:
You decide to buy a house. You can afford to pay 1,000/month, which is what your budget allows. Using mortgagecalculator.org, I found the following:
At 4%, a 30 year loan, with no down payment, you could purchase a home worth about $175,000, meaning your loan would be for the same amount (yes most people put a down payment on the home, so that would slightly change your loan amount and home value, but for the sake of simplicity I did not factor it in, or the PMI insurance that would go with a very low down payment).
Monthly payments- $1,017.77- not bad, pretty much right on our budget, just like we planned right? So what is stopping us from making the purchase?
How about property taxes, which at 1.25% would add over $65,000 to your payments. This averages out to be about $180 per month over the life of your loan. But don’t worry, your taxes will go up, and they do not stop when your loan is paid off…
You paid $125,771.64 in interest alone. That is almost as much as your original mortgage. So you can afford the monthly payments, but did you expect to pay $300,000 for your house?
I also did not include closing costs, which if you have to pay them, averaged about $4k for this home. If you are responsible for this expense, did you budget for it?
And then there is homeowners insurance added to the pile. Repairs will cost on average 1% of your home value per year. So our $175,000 home will add about $145 per month to your budget.
I could go on, but the point is, your original $1,000/mo budget was blown out of the water. This is common when making a purchase based off of what you think you can afford to pay each month. The solution to this is to factor in as many of those costs as you can and deduct them from your monthly payment you originally budgeted for. This will give you a reduced monthly payment for the home, but a more accurate picture of what you can really afford to pay each month for the house payment alone. A familiar term for this is called the “out the door” cost. Meaning, what will it cost me when everything is factored in, when it is all said and done, when the dust settles.
The same is true for cars. It’s not just buying the car, it’s also tax and license, tabs, insurance, gas, maintenance, improvements and updates, car washes too.
Even with smaller purchases like an Xbox, you should ask what the out the door cost is. You have to buy games, controllers, online access and more.
The point to take away is to think beyond the initial purchase. When considering a purchase, take a few minutes to brainstorm all of the other costs that will be associated with your purchase. Then try to factor in the cost, and subtract it from your budget. If it’s a house or car, it will mean adjusting your initial purchase amount to fit what is left after the additional monthly expenses, which also meaning the monthly payment for just the house or car will be less, and the end result meaning you may have to adjust your expectations of what you can afford, or wait and save up for a later date. For smaller purchases it may mean saving up for a little bit before taking the initial plunge.
Pretty much every purchase you make will have ancillary (extra) costs associated with them. I hope this article helps you realize that, and gives you some tips to making a fully informed decision about your next purchase.
For more articles by me, go to my blog at www.stewardology.com/blog