How to find out if you can afford something

By glblguy

If you gotta ask, you can't afford me

My wife and I found a another home we really liked while doing our house hunting trip over the weekend. The house is big enough and based on the limited research I did, the price looks right as well. The problem is that it’s above what we had planned to spend for a home.

We spent the evening discussing the house and whether it was something we really wanted or not. Most of our conversation centered on one topic: Can we afford it? This is an easy question to answer, but far more difficult to answer in many cases, especially for higher priced items like cars, homes, etc. This is also a question is a topic that comes up in our household frequently. We even had this same conversation concerning our trip.

Factor in all of the costs

One important aspect in determining if you can afford something or not is to know all of the costs. For example, when determining if you can buy a car or not you not only after factor in the cost or monthly payments, but also insurance, gas and maintenance costs. The same applies for a home.

I made this mistake when I decided to start a saltwater aquarium. I found a great deal on the tank and some supplies on Craigslist, and went ahead and bought it. What I didn’t factor in was the costs of additional supplies, fish and ongoing maintenance. Turns out, saltwater aquariums are an expensive hobby. In hindsight, I wish I had done my homework a little more.

How to find out if you can afford something

There are a couple of different options you can utilize to find out if you can afford something or not. Here are the two we use:

Use your budget

The first thing I generally do once I determine all of the costs associated with making a purchase is add those costs into our budget and determine the impact. Obviously if expenses are larger than income, the answer is almost an immediate no. I say almost, as there may be some opportunity to further cut expenses. Given my expenses are already fairly lean, cutting them further is fairly difficult to do.

If you’re income is still greater than your expenses though, than you should be in fairly good shape. Remember though, if you run a zero based budget like I do, adding anything to your expenses will put you in the negative. This means that you’ll need to back off on one of your other categories to make up for it. For me, this would be either my savings or my debt snowball.

Live as if you’ve already bought it for a while

Using the budget method alone works well for small purchases, but for large purchases where the cost is a higher percentage of your overall expenses (like a car or house) I’d recommend living as if you’ve already bought it.

Going back to the house we found..The house is going to run us about $700.00 more per month than we currently pay (our mortgage is very low right now). $700.00 is a big amount for us. We aren’t 100% sure we can afford it. The extra expense will bite into our debt snowball a bit, but looking at our budget we can do it.

The real proof isn’t by looking at the budget, but through actually living with the extra expense. What we are going to do is pretend like we already own it. Instead of making a payment to someone else though, we’ll just transfer to the money into our savings account. Not only will this help us to know whether or not we can live with the additional cost, but we’ll build some savings as well that will help us put more money down on it.

After a couple of months using this method, you’ll know pretty quick whether or not you can afford something.

Long term consequences

When making a large purchase, not only is it prudent to consider the month-to-month costs of a purchase or the upfront costs, but equally important is to consider the long term ramifications. How will the purchase impact your debt snowball? Will it impact your emergency fund or retirement savings? Or in the case of a house, will it actually increase your overall net worth even thought the house is costing you more monthly?

Don’t make the mistake of thinking just in the short-term, insure that you are making a wise long-term decision as well.

Each Monday here on Gather Little by Little I write about topics and techniques for saving money. This article is part of that ongoing series called Money Saving Monday Tips.

Photo by: iluvrhinestones

11 Responses (including trackbacks) to “How to find out if you can afford something”

  1. Miranda Says:

    Great article! We did the same thing when we bought our house. It helped us finish paying off our car (two years early!), plus gave us a little extra to put toward the down payment on the house.

    Good luck with your house hunting!

  2. Funny about Money Says:

    Well said. The decisions involved in making such a major purchase are never easy, especially when you’re young.

    My ex- and I had to stretch to buy each of the houses we purchased during our marriage. We lived in each about 15 years.

    We paid $32,000 for the first place and sold it for $130,000. Our payment on it was $300, which by the time we sold was pocket change. We paid $170,000 for the second, which is now worth about $1.2 million, even though it needs fix-up. The payment on it when I exited stage left was about $1,500 — the same amount my son and I are paying on the tiny Investment House, which is worth about $270,000 (supposedly) and is located in an iffy neighborhood.

    What happens is that inflation soon takes the sting out of a 30-year fixed mortgage payment. Your wages go up, while the payment stays stable. In a few years, the extra $700 will seem quite affordable.

  3. Steward Says:

    Those are some pretty good tips, I especially like the one about living like you made the purchase to see if you can afford it. But I have a question, what do you think about seeing if you can afford something the makes a pretty broad impact on several areas of your finances at the same time – like relocating? When you move your income and housing, food, fuel, travel, and entertainment expenses might change. How would you recommend seeing if you can afford that?

  4. Gina Says:

    I follow the 1/3 rule. Is the mortgage payment more than 1/3 of your take home pay?

    We followed the same process … put away a “mortgage payment” for 1 yr while we were renting. It helped us STICK to our best case mortgage payment scenerio too.

    Good luck! Take your time.

  5. LC Says:

    Another thing to ask about whether you can afford a house is can you afford the utilities/maintenance or “standard of living increase”. A significatly larger house will have higher heating bills. A house in a warmer climate (or if you never had AC before) will cost more to cool. A neighborhood that requires professional landscaping or where sprinkler systems are installed will increase your water bill. If your neighbors all send their kids to private schools or drive new cars, will it be difficult not to give into the pressure and spend more? On the other hand, some locations can decrease social pressure to spend/utilities, but it is something to consider.

  6. Monroe on a budget Says:

    I had paid off my student loans about a year before we bought our house. Instead of spending that extra money on monthly expenses, I set it aside to buy things like new dishes and new towels for the new house. Why? Because as soon as we had a mortgage, that money would be eaten up in housing costs.

    It was really great to move in with boxes of brand new pretty things!

  7. Investing For Beginners Says:

    maybe im a little weird, but an investment property is THE way to go. not a second home, but a rental. if you can get a mortgage as low as 700, thats awesome. have someone pay the property down for you through rents and your off to the beaches somewhere collecting excess money through depreciation!

    rinse repeat!

    …700 mortgages??? im moving to your part of the country lol

  8. Mydailydollars Says:

    Great thinking! I agree. . . living like you’ve already made the purchase is a great way to test the waters. Another factor to consider when moving is the neighborhood. Will you be trading up on the “keeping-up-with-the-Joneses” factor? One thing we like about our area is the fact that it’s a mixed-income neighborhood. That way we don’t feel pressured to buy cars, boats, or whatever to fit in.

  9. Financial Planners at Respond Says:

    Thanks for the great post. It will definitely help those who are going to or planning to buy home.

  10. glblguy Says:

    @Steward – Excellent question. If you can’t go ahead and live on those expenses, than just add them to your budget the best you can. Most expenses like that can be researched. I would just run a budget with the expect % increase.