Big purchases and expenses are inevitable in life. We save up, prepare, and try to anticipate when they may happen. Some are more stressful and anxiety-inducing than others, like paying for a new roof, replacing a totaled car, or figuring out how to finance college or weddings. These situations force us to think more about our financial situation because they tend to be more expensive.
Adding to the stress are the rising interest rates in our current economic environment. Even the monthly payments on loans start to look scarier. Currently, average auto loan rates start at 6-8% and go higher. The average monthly payment for a new car has reached $716, assuming a loan term of almost 70 months. Used vehicles are not much better, as their prices remain high. It’s natural to feel uncertain about whether to be more concerned about a $716 monthly payment or paying it for nearly six years.
Mortgage rates are hovering around 7% for a 30-year loan. Buy now, pay later services are becoming more common, even for small purchases. Credit card rates average between 20% and 30%. Personal loans and payday loans come with even higher rates.
Considering these numbers can be worrying, especially when planning a significant purchase in the near future. However, if we adhere to sound financial principles, we can make better decisions.
First, we need to analyze whether it’s a need or a want. Can we do without it for a little longer? Those who exercise delayed gratification might find themselves in a better position when prices decrease and interest rates stabilize.
Second, we must assess affordability. We should evaluate our cash flow and monthly income to determine if we can handle a lump sum payment or the required installments. Do we have enough cash on hand to pay for it outright? Will we still have our emergency fund and enough cash for future large expenses? If the answer is yes, then we can afford it. However, if we don’t have enough money at the moment or only have partial funds, we need to consider our debt-to-income ratios for financing the purchase.
Welcome to Personal Finance 101. Your monthly housing debt payments should not exceed 28% of your gross income. Your total debt, including housing, should not exceed 36% of your gross income. Some individuals prefer to calculate these ratios based on net income instead of gross pay, taking a safer and more conservative approach. For instance, let’s assume a yearly income of $60,000 for simplicity. If your monthly gross income is $5,000, your upper limit for mortgage or rent should be $1,400. Suppose you have student loans, a car payment, or other debts. In that case, your upper limit, including those expenses with your housing costs, should be no more than $1,800. There’s not much room left for a $700 car payment in this scenario.
Staying under these ideal ratios allows you to afford other unexpected expenses that arise in life. If your ratios are much higher, say in the 40%-50% range, it may be challenging to maintain the desired lifestyle in the long term, and unexpected purchases can significantly disrupt your financial stability. These guidelines help us avoid overextending ourselves and staying within our means.
In this environment of high prices and interest rates, it’s crucial to monitor your spending, manage debt, and stay informed about current rates. Avoid high-interest debt, understand your ratios, and assess whether you can genuinely afford your purchases. If you’re not in the financial position you desire for milestone purchases or where you need to be in the future, remember that we’re here to help you plan your path forward.
