“Can I Afford To Buy This?”

A friend recently came to me, looking for advice about purchasing a new car. Now, this friend and I have some differences in our basic views about money, and particularly car payments. As you know, I believe that one should avoid car payments whenever practical. My friend believes that car payments are a way of life, and she has no plans to change.

My friend has a perfectly fine car, and she still owes about a year on the loan for it.  It wasn’t an large loan and the payments are around $200 each month.  She is proposing that she sell the old car, pay off the loan, and buy a new car with a new loan.  The old car isn’t worth much more than the remaining loan balance, and she only has about $1000 to put down towards a new car.  She wanted my advice.

Here is where giving financial advice can be tricky.  What I want to say is, “What?  Are you nuts?” and then go on about how she should pay off her old car and continue to drive it forever.  However, this person isn’t going to listen to that advice.  I have to craft some sort of plan that would improve her finances without making her feel like I am telling her not to buy a new car.

Here’s what I came up with, and I think it is a relatively good compromise.

I worked out the car payments on the new car – about$400 per month.  I advised my friend that she should start making that new, higher car payment toward her current loan.  If she can make the $400 per month car payment every month, for a year, without feeling like she is broke, then she will know that she can actually afford the $400 car payment.  As a bonus, her old loan will be paid off in around six months.  Once the old loan is paid off, she can put the $400 per month into a savings account, to be used as a down payment on the new car or as an emergency fund.  A larger down payment means that she can select a shorter term for her loan, which might get her a better interest rate and will definitely help her overall financial picture.  And an emergency fund is always good!

This strategy works for other credit purchases, such as mortgages.  If you’re considering buying a house, try paying yourself that mortgage payment (plus about 20% for the incidental expenses that come with owning a house) every month for a year.  If it isn’t problem, then you will truly know that you are probably capable of handling the mortgage payment for thirty years.  (Plus, you’ll have a nice emergency fund.  Houses need emergency funds.)

While I advocate saving first and spending later, I recognize that there are times and situations where this advice isn’t going to be followed.  This “try it for a year” strategy takes some of the risk out of using loans for purchases by testing your ability to make the payments.

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.
  • Shannon

    I think that’s fabulous advice and have a question regarding your idea as it relates to a mortgage. If a person is presently renting a home, would they pay themselves the difference between the rent and what a new mortgage payment would be AND 20% for incidentals means what? 20% of the monthly payment each month or 20% of the entire loan per month/year?

    • Kate

      Shannon, I budget 20-30% more than the scheduled monthly expenses, and keep the extra in a dedicated savings account. For example, our mortgage payment, which includes the loan payment, taxes, and insurance, is just under $2000 per month. Our utilities run about $400 per month. I move $3000 each month into our house account, pay the mortgage and utilities, and then let the rest (typically about $600 per month) build up. So, if I were trying to see if I could afford our $2000 mortgage, I’d actually be trying to make that $3000 payment. Does that make sense?

      Because most people are paying rent, or another mortgage, while figuring out if they can afford a new house, you’d want to calculate the total costs of the new house, then subtract the total costs of your current house.

      One easy way to do this is to use the same account. Make the proposed larger payment into your house account, but pay your current housing bills from that account. Obviously, your savings won’t grow as fast, but you’ll be showing yourself (and the bank) that you can afford the expense.

  • bbabbitt

    Our troops are using EBT cards to support their families while states continue to boost their minimum wages to the stratosphere. It is not very comforting to realize the people making and selling your Happy Meal make more than those taking rounds on the front lines.

    • D. Ridenhour-McHenry

      Wow, that’s an excellent point, Bbabbitt! Thanks! Remember to factor in the worth of health and dental care, BAH and the other privileges of being in the Armed Forces…..one forgets about that…..merely looking at the pay stub.

      • Bassmusic

        And “Wow, that’s an excellent point” to you, D. Ridenhour-McHenry! I remember getting dental care in the Air Force as a privelege that I took for granted, but now that is an out-of-pocket cost for my particular priority group as a veteran. I remember when I got to go on leave twice a year. Since getting out of the A.F., I have only taken two very brief vacations in 15 years, because if I don’t work, I don’t eat! BAH, clothing allowances and a regular paycheck that I can count on to be there when I’m sick (or any other time, for that matter)–no such animals in the civilian world that I’ve personally experienced.

        Like my peers, I used to blow off that annual letter we all got that outlined those military benefits we took for granted. If I only knew then what I know now…