Cash Flow: Are Your Monthly Payments Actually Affordable?
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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%.
Horrible rate, I now realize.
Anyways, my car payments came out to 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.
I would've paid about $6,000 in interest for this car. 👀
Fortunately we paid our car loan faster than planned and saved quite a bit of money in the process.
Mortgage Payments and Total Amount Paid
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
Guess how much that $200,000 mortgage will actually cost you?
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 start building that margin so you can reach your financial goals faster.
Not sure where to start? Here are some of my favorite options for tracking and managing your budget.
By using an app, you can quickly and easily see your monthly cash flow and adjust it as needed.
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?
The answer depends on what goals you're pursuing and whether or not you want to take out a loan.
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.
I'd love to hear from you! Do you tend to buy things outright or do you use installments? Have you considered how much interest you're paying for your stuff?
Depending on how busy the year is I try and review all of the interest rates on my loans/lines of credit every six months or so. Even if most people can’t afford to pay down an expensive car loan early it may still be possible to get a line of credit and transfer the balance to that. I have some good friends who did this and instantly cut the interest rate that they paid on the car from approximately 12% down to 5%, thus saving alot of money.
To me, credit and installment plans have helped to ruin our personal finances. People only focus on the monthly payment when deciding to make a purchase. Many will pay any price as long as they can get a manageable payment!
Thanks Matthew and Khaleef! Looking at just monthly payments is short sighted in many cases. I think if people examine total purchase price they would modify their spending habits.
That example of the car costing 50% more is a perfect illustration. Credit is useful for two reasons:
1. You need something now and don’t have enough money (typically useful for really big-money purchases like real estate, vehicles and vacations
2. You don’t want to carry around that much cash in your pocket for security reasons.
Either way, pay down as much as possible as quickly as possible…unless you really want to pay a higher price.
With the exception of my house, I always try to buy outright (and hopefully my next house I can buy outright!). Your post is a great reminder of why we need to always shop based on total purchase price. We all need to be aware of what interest we are paying. And since compound interest is the most powerful force in the universe (according to Einstein), I always try to earn it rather than pay it!
When I bought my last car I told the dealer I was interested in the total cost of the car not the monthly payments. He was stunned and remained quiet for a few moments before telling me that no one had ever told him that before.
He was trying to sell me a more expensive brand new car with lower monthly payments, instead of the second hand car that cost less in total, but had slightly higher monthly payments.
I told him I did not care what the monthly payments were because I could find a way to make that..but I did care what the total cost of the car was!!!!!
I did the same thing! Just negotiated price of a car for my mother. I asked to negotiate the price of the car instead of all the other things like payments, trade-in, financing, down payment. Very smart move!