Avoiding Debt – What Can I Really Afford?

Ever heard someone say, “Oh yeah, you can afford that!” just before you bought something, which leaves you with the bill later? It happens to everyone and knowing the pitfalls is the first step. I will point out tricks and one-liners that fool us into spending more than we intended. Once you know what to look for, we can get you on a plan to avoiding excessive amounts of debt.

Sales Tricks
Have you ever spent money just to save money? We all have and somehow we get a warm and fuzzy feeling when we do it too. Every business has these promotions packaged up differently. If we buy fuel from a gas station, they will save us a dollar on a car wash, buy three DVDs and get the fourth free or even buying a combo at a fast food restaurant even though we only wanted the sandwich and a drink. If we buy more than we need just to get a kickback, was it really a deal or a sneaky sale? A savings only happens when we buy exactly what we need. If you spend an extra dollar to save fifteen cents then it becomes a very poor investment, not a steal. Even at the grocery store when we check out we are told we saved “X” amount of dollars. They never say how much we spent but only how much we saved. It makes us feel good to know we saved money when, really, all we did was spend. Spending is why we as consumers find ourselves in debt, not the supposed savings we think we got. Of course, we need to spend money and I am not suggesting never buying groceries for example. Many times, we just cannot pass up that sale even though we hardly ever use that particular item. Next time you spend money, look for the gimmick that tries to make you believe you are saving money and not spending. I think you will be surprised.

Another classic sales trick is someone telling you what you can and cannot afford. Should we not as educated citizens be able to determine that, absolutely, but not in today’s world. Most of us have a particular car and a house because someone looked at how much we earned, did a quick calculation and spit out a number. We never did the math ourselves or considered other options; we just took a total stranger’s word for it and believed him when we said we could afford it. You will be amazed if you actually did some of that math on your own. Depending on your area this may be difficult to do but a multimillionaire was told me that your house should cost you twice your salary. You may laugh since houses can cost hundreds of thousands depending on supply and demand and other factors. I would take a hard look at that calculation. Divide the cost of your house by your salary. If both persons are working, you could combine that number but beware of several factors. If one of you was not planning to work long or if you are expecting a child and you start to live off one income, the mortgage amount stays the same. It is not as obvious as it sounds since many buy when both persons are working and have bought a house on that assumption. Make sure you can live there on just one income. After you did the calculation, and are between one and two, you are on the right track. If other expenses are low, I believe you could start saving and investing. However, you are probably feeling the pinch if that golden number is three and higher. Did you realize that you have just enough money to pay every month but not enough to furnish your new place? Letting someone else tell you what to buy or home much to afford will leave you strapped and perhaps living paycheck to paycheck. Figure out what you can afford especially when it comes to your house and vehicles.

Even our friends ask us questions that lead to spending more. When you were looking for a house, did you ever hear someone say, “How big of a house are you looking for?” That immediately puts you in a level of thinking that indicates it should be as big as possible. When you ask your realtor what you can afford she will tell you as big of a number as she can get away with. The question we should ask our friends is this, “How big of a house can you get with the money you budgeted for?” If you know you only want to spend 25% of your income on a mortgage, it narrows your options down quite significantly. Finding the best house in a narrow budget range is much more financially sound than finding the house you want and trying to figure out how to make the payments. When it comes to purchases, no matter what the size, determine how much you can afford to spend and find the best that money can buy rather than doing it backwards.

Monthly Payment Scheme
When was the last time you bought something and you actually knew how much it cost? I bet you can tell me how much it is per month but not the total amount. You can finance anything and most people do. Electronic stores are great for this; they say an item is $11 a month but never how many months and what the total cost will be. This strategy is simply pushing debt out in front of you. The lower the payments, the higher the interest rate and the longer you will be paying on it. Companies love it since its more money for their coffers and you as the consumer feel that you are saving money every month. Thinking in months is just too small of a period for that to compute in our brains. I could sell you a car for only a buck an hour, who cannot afford that. The question is we can all afford until you find out that translate to $750 a month and $9000 a year. The saying, “buts its only” followed by a small unit of time (e.g. month) has cost everyone money and it fools us all. Think in terms of years and you will say NO more than you think. Another important question we have to ask ourselves is if the only way we can afford something is by pushing debt in front of us, can we really afford it. If we do not have the money now, why would we have it tomorrow? Tomorrow’s money has most likely been spent. The definition of insanity is doing nothing different and expecting different results. Get a handle on that future debt which is everything you are paying off on a monthly basic.

Standard Of Living Pressure
Many times keeping up with the proverbial Joneses is more important than maintaining a strict budget. In the 1990s, it was normal to see many old rusted cars on the roads. Not anymore, everyone is driving newer vehicles and you have to really look to find that old, beaten up car. We are all living better and have less outdated things than ever before. The pressure to spend and live well has caused us all to get off track. How many times have we asked graduates when they were going to buy that new car right after they started their first job? We probably even tried to sell them on how much we thought it could save them or how low the monthly payments would be. After we got our first job or perhaps a pay raise, the first question we asked ourselves is how much more we can spend. Did saving and investing never become an option? We look first how to spend and look second (if ever) on how to save. Its no wonder the average American in 2005 had $8000 in credit card debt. You are losing thousands in interest if you pay just the 4%, $320 a month minimum. Imagine if we pressured our friends to invest, save and conserve rather than spend and live well beyond our means? It is time to break out and set a new standard.

Lack of Budget
Spending is a lot of fun and it is gratifying to see our hard work pay off. I challenge you to write down every dollar you spent this month so you can see where it is all going. You will be surprised. Your Starbucks coffee each day can really add up. If you are thinking hundreds, may I suggest thousands, to the tune of $1500 on the conservative side? If you put that into an investment earning 10% a year for 20 years, you would be looking at $100,000 dollars. Sound unbelievable? It is true but I am sure that coffee is important. If you started saving that when you were in your early twenties, you could put your firstborn through college. If you drink three coffees a day, the math works out the same and you could put three kids through college. A strict budget adhered to for decades will leave you in comfortable shape later in life.

The national savings rate is close to zero if not negative in 2006. If you are not saving 10% a year, a budget is absolutely needed. In 2005, the average American spent 125% of their income. In order to save 10%, you can only spend 90%. Most budgets would not reflect that no matter how obvious it sounds. You may have to move and sell those new vehicles in order to save but it will be worth it.

Delayed Gratification
Our culture loves to spend money before we have even earned it. Most of us run out of money before we run out of month. About the 25th, we have spent all of the money and there is still a few days left. Know the feeling? Delayed gratification is putting off a reward until we have accomplished a certain goal. If you have credit card debt, you could stop eating out until that debt is gone. If you want new clothes, find a goal before running out and buying clothes just because there is a sale going on. You could pick up side jobs for extra income before rewarding yourself.

Change Your Thinking
The mind is a powerful tool and we unfortunately never use it. A tool takes years to sharpen and becomes dull and useless if we never learn to stretch ourselves. How can this help get you back on the road to financial security? Train our minds to think about how to make money rather than spend it. A raise, bonus or tax return often puts money in our hands just waiting to jump back out again. Imagine buying a car just from the dividend and interest returns of your saved money. Passive income is dividends and interest paying you on a monthly or quarterly basis. It pays us whether you are on vacation or sleeping, it never stops. Passive income is a power tool that you need to learn more about and it will change the way you spend money.

As you can see, there are many pitfalls to avoid and a lot of rewiring we need to do to ourselves. It is a process we all have to work on daily and the rewards for doing so are priceless.