How to find out if you can afford something
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