How to Decide if You Can Afford a Large Purchase

I’ve often read that September and October are the best months to buy large appliances. Since our washer and dryer are showing signs of calling it quits, I’ve been thinking about whether or not we should go ahead and buy new ones while they’re on sale. When trying to figure out whether or not it’s the right time to make a big purchase like this, including cars, furniture or even booking a long-awaited vacation, there are a few ways to look at whether you can afford it.

  • Cash is King
    Ideally, you’d pay cash. As long as you don’t need to dip into your emergency fund, paying cash for the purchase of depreciating assets (or stuff that you won’t be able to sell for as much or more than you paid for it) is the best way to go – yes, even for cars. (For help saving up, try the no-tracking budget.)
  • Same as Cash or 0% Promo Rates
    If you don’t have the cash saved yet, then look at same-as-cash financing deals, but only if you can actually pay the balance off BEFORE the interest kicks in. To figure out if you can afford to do that, divide the purchase price by the number of months you’d get interest-free. For example, if it’s a $1,500 purchase on a 90 days same-as-cash deal, you’d have to pay $500 per month. Can you afford that payment? If not, don’t use the same-as-cash deal. It’s not worth it. If you’re using a credit card with a zero percent promo rate, the same rules apply. It’s only a deal if you can pay the balance in full by the end of the promo rate. Otherwise, the high interest rate that will kick in will inflate the price of the purchase beyond reason.
  • Financing with a Loan or Credit Card
    If same-as-cash or zero percent financing isn’t available (or you wouldn’t be able to pay the balance by the time the zero percent period ends), then there are a few things to consider before you take out a loan or use a credit card. First, make sure you’re considering the total purchase price including interest. To figure out how much interest you would pay, use the cost of credit calculator. When you add the interest to the amount you’d be paying for the purchase, is it still a good price?
  • Debt Rule of Thumb
    Finally, anytime you’re considering adding a new monthly payment to your budget, make sure that your total debt payments won’t exceed 36% of your gross income. For example, if you make $50,000 per year, then you would want to keep your debt payments to $18,000 per year or $1,500 per month, including your mortgage. So if you have a mortgage payment of $1,000 and a student loan payment of $250, and you’re looking to finance a car, you could reasonably afford a $250 per month payment.

In a perfect world, you would never finance something that you couldn’t sell for its purchase price or higher. This is why it’s a financial folly to charge clothes or food on a high interest rate credit card if you’re not paying the balance off every month. But in times when debt can’t be avoided, having a plan to pay it off is the best way to avoid getting yourself in financial hot water.

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