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Are you tempted when you see the new car ads with such low monthly payments? How do you personally decide if something is affordable? What role does your monthly cash flow play with your budget?
I want to share how looking total purchase price vs monthly payments can dramatically improve your finances. When I changed my mindset, it became easier to watch my spending.
Total Purchase Price – An Eye Opener
Besides looking at the payments, you might want to look at the total purchase price. The first time I did this was with my credit cards. I read in a personal finance book that you end up paying a lot more due to interest if you only make the minimum payments.
The same thing with my car loans. The interest rates were horrendous and paying them on schedule meant I was paying way too much for my car.
I bought a car for about $10,000 at an interest rate of 13.75%. My car payments were around $230/month. With all the finance charges and fees, if I stuck to the car payment schedule, I would pay a total of $15,962. Fortunately we paid our car loan faster than planned and saved a bit of money in the process.
Now let me show you another an example, this time with a much bigger purchase. Most of us can't buy a house outright, so a low interest mortgage can make sense for some of us.
Here are the numbers for a house:
- Mortgage: $200,000
- Interest Rate: 5%
- Length: 30 years fixed
If you paid on time, at the end of 30 years you will have paid $386,517.71. That's almost twice the purchase price for interest!
While there's nothing wrong with getting a mortgage and paying it on schedule, how many times have you thought about the total cost of your house? It's an eye opener and you may think twice about rushing into becoming a home owner.
Using a Cash Based Budget
Mastering your cash flow can help you see how important budgeting is for you. Here are some of my favorite free options for tracking and managing your budget.
- Mint: As you see with our monthly net worth reviews, I use this often to keep track of my spending habits.
- Quicken: The most popular money management software has a lot of capabilities with budgets, investing, real estate, and more. Examine the features of the different editions before you buy to make sure you grab the best fit for you. Here is a review for Quicken 2011.
- Pocket Smith: This is a really useful budgeting calendar and forecasting web tool.
- BudgetPulse: A strength of BudgetPulse is the visualization of expenses and income.
- Google Docs: There are several free templates you can use to get your budget up and running.
Take some time and try them out. Choose what works best for you and your finances.
Do Monthly Payments Make Sense?
Looking at the other side of the coin, even if you can afford to pay upfront for a good or service, it may make financial sense to go with payments.
Can there be times when taking monthly payments can be advantageous? For example, what if you were offered a 0% interest rate for 3 years on a new vehicle? Would you pay for it completely still or would you deposit your money into an account that can earn you some interest?
Thoughts on Buying What You Can Afford
Taking a look at how budgets and cash flow are related can help you figure the best plan to build your net worth. Do you tend to buy things outright or do you use installments? Have you considered how much interest you're paying for your stuff?