Life is a constant stream of decisions, most of which come and go with little impact or fanfare. Then there are the big ones, the decisions of the life-changing variety. You know the ones: whether or not to marry and to who, to have children and how many, to quit your safe, comfortable corporate job to start your own business.
Given how far-reaching the impact, it’s critical we get these life-changing decisions right. We inherently understand this when it comes to marriage or having children but it’s a foreign concept when it comes to our money.
As in our personal lives, some financial decisions have a disproportionate impact on our financial lives. We’ve identified the “Big 3” spending decisions that have a disproportionate impact on our financial lives. These decisions are capable of restricting our financial flexibility, and with it, our ability to live the lives we dream of.
The Big 3 – Home, Car, College
Let’s talk about why home ownership, car ownership, and an expensive degree can be such a drag on our ability to live life.
Buying a house
Society tells us that to be a successful adult, we must buy a house. That’s what responsible grown-ups do, they become homeowners.
While I am a big proponent of homeownership, it’s not the right choice for everyone. Buying a house is the largest financial decision most people ever make. And, while it can be a good investment, it’s not guaranteed.
Before diving into homeownership, here are two questions to consider:
- At this point in time, is buying a home the right financial and lifestyle decision for you and your family?
- If you choose to buy, how much house can you afford?
The answer to question number one can be as simple as comparing the cost of renting versus buying. However, it’s also worth assessing the impact on your lifestyle. Do you value flexibility or consistency? Do you like to move around or change jobs frequently? Are you interested in taking on the responsibilities required when owning a home?
Buying inherently restricts your flexibility – financial and otherwise. This doesn’t make it a deal-breaker, you just need to understand how far-reaching the trade-offs go.
How much house can you really afford?
There’s a difference between how big a mortgage you qualify for and what you can afford.
Mortgage lenders look at factors like your credit history, salary, and debt. However, they don’t consider how many kids you have to put through college, what your retirement dreams are, or the cost of health insurance.
When determining how much mortgage you can afford, think about the lifestyle you want to maintain. The intention is to avoid being house rich and cash poor.
“House rich, cash poor,” is when a substantial part of your paycheck goes towards your “house.” It’s not just your mortgage, but also includes home insurance, property taxes, utilities, and home maintenance.
While we all want a home we love, a house that’s too expensive will quickly lose its luster when it impedes your ability to travel or even go out for dinner.
There’s also the risk purchasing too much home will push you into debt. All too often people don’t cut back their spending. Instead, they go into massive credit card debt trying to live a lifestyle that matches the big, new house.
This isn’t to scare you away from homeownership. Again, I’m a huge proponent of home ownership. Rather, it’s to encourage greater awareness before you commit to that big payment.
Homeownership can be great, but having a house that eats up all your income means you’ll little money left to do anything else.
Buying a car
I always shake my head when someone purchases a new car and calls it an investment.
When you invest in something, like the stock market, you expect it will be worth more in the future. That’s an investment. A car is not an investment because, unless it becomes a collector’s item, it will never be worth more than when you purchased it. Just because it retains some of its value doesn’t mean it’s an investment.
Buying brand new vs. new to you
According to Carfax.com, as soon as you drive your new car off the lot it depreciates by 10%. By the end of the first year, it drops by 20% and after five years, 60%.
Such massive losses in value over a short period of time makes buying “brand new” a less than ideal financial move. It’s also what makes buying a slightly used car, say 2-3 years old with low miles, such a good deal. You get a quality car, in great condition, for a fraction of the cost.
The primary objection I hear for not buying used centers around higher repair costs. But if you buy slightly used with low miles, this concern is more imaginary than real. Today’s cars are built better than ever before and require less maintenance to boot.
Now, there are a lot of personal reasons for buying a brand new car and they matter. Just don’t fool yourself into thinking “having more money” or “it’s a good investment” is one of them.
The bottom line: it costs you more to buy brand new. Which is perfectly fine if you can afford it.
If you can’t, the same lack of financial flexibility issues you run into with buying too much home apply to buying too much car. What good is it to have a shiny, new ride but you can’t afford to drive it anywhere?
Going to college
If you’re reading this, chances are it’s already too late for you, personally. You’re out of college and there’s no way to turn back the clock and unwind things. Hopefully, you’re not behind the eight-ball with student loans.
But, it’s not too late for your children. Or your grandchildren, nieces, or nephews.
I know there’s a lot of talk on Capitol Hill about student loan forgiveness and the like. Who knows where that will go, but it doesn’t change anything for those who don’t already have student loans on the books.
If we don’t make different choices for our children and grandchildren, we’re going to have the same problems we face today. And the real problem is far too many people are buying too much college.
Future student loan crises can be avoided if we did one simple thing: bought as much college as we could reasonably afford. Granted, determining what you can “afford” is a bit trickier than with a house or car, but the governing principles still apply.
Which begs the question, why do so many buy more college than they should?
To answer this question fully is beyond the scope of this blog, but it revolves around three themes:
- Equating a high priced education with a quality education (quality being defined as the ability to get a job once graduated)
- Forgetting the primary purpose of going to college (to be a higher quality job candidate, not to “find yourself”)
- Poor financial planning (failing to put pen to paper on the real financial impact once payments begin)
The problem with buying too much college is the same as with buying too much home or car. You have a high, fixed payment over an extended payback timeframe which severely limits your spending options.
The big three
I often hear people say they can’t save for retirement, travel more, or reduce the number of hours they work.
And they’re right.
They can’t because they’ve failed to understand the debilitating impact of buying too much house, car, or college.
In the moment, they all thought they could make their payments and still enjoy a comfortable life. They were half right. They’re able to make the payments, but it’s severely dampened their ability to have a comfortable life.
“Save for retirement, take a two-week vacation, work less? How can I do those things and still pay my debts?” With a big mortgage, new car payment, and high student loan debt, “How?” indeed.
This is the real impact of not getting the Big 3 right. Years and years of grinding away and feeling like you have no way out. It’s a real problem. A problem best avoided than taken head-on.