During the heady years prior to the financial crisis of 2008, many people thought that they could “afford” bigger homes.
Unfortunately, as low-rate mortgage reset, it became painfully obvious that those homes weren't affordable at all.
But we don't have to go nearly that big. In college, I assumed I could afford something because it fit neatly on my credit card.
Often, I bought items immediately, telling myself I could afford it because I could just pay it off with my next paycheck.
Sadly, what usually happened is that I found I couldn't pay off the credit card balance; only the minimum payment was affordable.
Before you buy something — especially if you use credit to do so — it is a good idea to take a step back and see if it really is affordable.
Do You Have the Money for It Right Now?
One of the first questions you have to ask yourself is whether or not you have the money for it immediately. While this might not be practical when considering whether or not a mortgage or education loan is affordable, it is something to consider before you swipe the credit card for just about any purchase.
Be honest: Could you pay off the credit card tomorrow?
If not, perhaps it isn't affordable after all.
Does the Affordability Rely on Special Financing Tricks?
Next, figure out whether or not the affordability is a result of special financing. When purchasing a home, this is especially important.
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Could you afford the mortgage payments if you didn't get an interest only loan?
If the teaser rate reset tomorrow, would you be able to handle the higher payments?
This also works on the basis of making other types of purchases.
Could you buy that TV without the “special” financing deal of nine months without paying interest?
If the only reason that you are able to afford a purchase is due to efforts to temporarily adjust your financing terms, that's a serious red flag.
How Will the Purchase Affect Your Long Term Financial Goals?
When Kyle a the Amateur Asset Allocator talked about his view of affordability, he mentioned his long term financial goals. Are your purchases now impacting your ability to meet your long term goals later? If you find that you don't have enough money to put what you want toward your retirement account, it's probably time to review your spending, and see what is holding you back.
Even though you might have the money right now, what it is taking away from in terms of the future? Something that puts your future at risk is probably not affordable, even if you pay cash for it right now.
Your budget, and your spending, should reflect your priorities. Affordability is about more than just figuring out if you have the immediate cash, or if you can handle the payments for a little while. Instead, it's about how the purchase fits into your overall financial plan, and whether you are meeting your financial goals.
Before making a purchase, re-examine your situation, and decide if you truly can afford it.