Cottages, Colleges and Cars: Budgeting for Big Expenses
Every so often, I like to take a minute and think about how absurdly expensive things are. A reasonable house for $400,000? Before any of the taxes and repairs and countless other expenses that come with homeownership? That’s crazy!
But, as they say, that’s life. If you want to buy a house, you have to be ready to pay market value. If you need to get behind the wheel of a brand new car, you might spend a year’s salary making it happen. Your choices are only to accept it or avoid it, because you won’t be able to evade it.
Once you decide you’re ready to own a big-ticket item, you can’t walk into the purchase blindly. You need to be smart about how and where you shop, and you need to be absolutely brilliant about saving money to make sure you can cover the cost. When you leave a little room for doubt, that’s when debt sneaks in and makes everything a lot more complicated.
I don’t want anyone to feel like they’ll never have the means to buy a house or car, or send a child to college. If you have these goals, I have every confidence you’ll be able to make your dreams come true. Financial savvy can be learned, and if you put in the effort you can figure out how to earn the money you need.
That said, thousands of spendable dollars don’t just appear overnight. Saving the money necessary for a big down payment or a year of tuition takes a lot of resolve, and it requires some thorough, detailed, sometimes sneaky budgeting. That’s what we’ll discuss in this post, and hopefully you’ll get a clearer idea of how you can afford the things you want most.
Budgeting for a House
Before you’re even allowed to think about buying a house, you need to get out of debt. Taking on a mortgage when you have unpaid credit card balances and student loans is a risky proposition, so I’m standing firm on this point. Go pay off your debts, take all the time you need, and this article will be waiting right here when you’re done.
With that out of the way, you can dip your toe into the pool that’s full of other prospective homebuyers. That – the extreme competition that comes with purchasing a nice house – is something that can really mess up your budget, but we’ll get into that in a minute.
Your first step should be to create a general budget that accounts for all your monthly expenses. If you skip this step, there’s a good chance you’ll buy a house you can realistically afford. Before you even look at the market, calculate how much you bring in each month and how much you need to cover immediate expenses. In its simplest form, you should have a list that looks like this:
- Income – Inflow: $5,500
- Food – Outflow: $400
- Gas – Outflow: $125
- Savings – Outflow: $800
- Medical – Outflow: $300
- Travel Savings- Outflow: $150
- Personal – Outflow: $400
- Bills – Outflow: $400
- Entertainment – Outflow: $200
I don’t think your monthly spendings should look exactly like this, but these numbers will work for our example. Also, you’ll notice I left rent off this list; that’s because the goal is to see how much you can put toward a mortgage.
After you subtract your expenses from your earnings, you get $2,725. That’s money you can theoretically put toward housing costs. With that figure in mind, you can start investigating mortgage rates. However, as you start gathering information, you also have to start making your budget more detailed.
Even though you have an estimate for your housing expenses, you still have to break down what exactly those expenses will be. Can you afford a mortgage that’s $2,700? Absolutely not! That leaves you $25 to cover repairs, taxes, and all the other costs that come with buying a house. You might be able to get away with a $2,000 mortgage, but even then you may want to aim a little lower to leave some wiggle room.
We’ve also jumped the gun a bit, as these numbers don’t account for a down payment. The bigger down payment you can make, the easier it will be to pay off your house. Lots of advisors suggest you target 20% down, which may or may not be feasible. Using the above budget sample, you might be able to get away with a lower amount, especially if you’re a first-time homebuyer. In any case, you should start saving up several months before you start tossing out offers for properties.
The amount of your down payment can affect your interest rate, which will be a big factor for your long-term budgeting. Ideally, you can get a 15-year fixed-rate mortgage; that should keep your interest fees somewhat manageable. No matter what the exact terms of your mortgage, you need to keep the monthly payment within the established ceiling for your housing budget.
Analyzing your finances and setting specific spending limits can feel, well, limiting. Your favorite house on the market might be just out of your price range. As I mentioned earlier, other people may drive up the cost of a house you thought you could afford. It’s unfortunate, but it’s how things work.
As circumstances encourage you to dig deeper into your pockets, you have to resist the urge to squeeze your budget a little tighter and pay more for a property. This is almost always a bad approach. It’ll be harder than you expect to cut back on your expenses, and you’ll end up buying things like groceries and gas on credit. After a few months living this way, you’ll have a whole new debt pool on top of your mortgage. You need to do whatever it takes to stay within your means.
Buying a house isn’t easy, but it isn’t as impractical as you might think. If you can keep your spending in check until you have sufficient savings and no other debts, establishing a budget and finding a house within your price range is suddenly a possibility.
Budgeting for College
Remember how we started the last section? The same guidelines apply here, though it’s a wee bit different with education expenses since they might involve your child. The rule of thumb is get out of debt as fast as possible, but creating college accounts for your kids and paying down debts simultaneously is something I’m willing to accept.
Budgeting for college requires a very different strategy than buying a house. The cost depends on the school, state and program. Repayment is usually delayed with student loans and interest rates can be very low. Compared to a mortgage, the monthly payment is minimal – you just have to remember the repayment processes often start before the graduate has a job.
A college budget can also be altered by lovely things like grants and scholarships. You can’t plan on receiving free money when you’re trying to save, but you should do everything in your power to get your hands on it. A small grant or partial scholarship can make a huge difference over four years. Nevertheless, as you start to save and plan ahead, keep scholarship expectations at bay.
If you start early enough, all you have to do is make a category in your budget for college savings. If you’re a really good planner who dives in the moment your son or daughter is born, you can figure out how much you have to put away each month for 18 years to reach a certain amount. If this is your tactic, look into tax-free savings accounts like 529 plans or IRAs. When you’re going to be saving for a full 18 years, that’s a lot of tax-saving and interest-earning potential.
Of course, not everyone has the luxury of saving for nearly two decades and paying for an education. Even parents who start saving early might come up short because of ever-rising tuition rates. You may have to do some last minute budgeting for your child’s or your own college expenses, and you need to be smart about it if you want to avoid becoming another student loan statistic.
There are different models people use for how to handle tuition fees. Like with buying a house, it’s great to have a chunk of money ready to go. This lets you borrow less and makes it easy to plan for repayment. Some people try to target saving up a third of the total tuition. That allows for three earning and payment stages: a third up front, a third to be earned and paid during the schooling years, and then another third by way of student loans. I don’t love the idea of that kind of debt, but it’s far better than borrowing all of it.
If it comes down to it, you are allowed to take time off while pursuing your degree. If you get through two years of a bachelor’s program and need a break to build up some capital, do it. There’s no prize or debt relief for finishing school in one sitting.
At the end of the day, how you budget for college and when you start saving money should depend, in part, on your career aspirations. You don’t have to go to an expensive private school to land a good job, and if your plan is to start in an entry-level position with a good company and work your way up, significant student debt will only get in the way.
Your best bet for a college fund is to save early and often. When it comes time to enroll, see how much money you have, what financial aid might be available to you, and then start looking into schools that are both respectable and affordable.
Budgeting for a New Car
I think you know how I’m going to start. No debt. Moving on!
I give the least amount of leniency to this kind of budgeting. With school, you can’t overlook the importance of a good education. With housing, you can’t get around needing a place to live. With a car… you can get around spending $30,000 on a new car.
With that said, getting to and from work and all the other places you need to go is unavoidable. You need a vehicle that you can depend on. If you have kids, you want a car that meets strict safety standards, and sometimes you have to pay a little bit extra for that. There are plenty of good reasons to invest in a nice automobile.
The budgeting for this purchase is similar to the homebuying structure, so you’re already well prepared. Start by working out your expenses and your earnings, do the math and see what’s left over to put toward a new car. Now you have the amount that’s available for a lease, though you also need to be mindful of these expenses:
- Registration costs
- Extended warranties
When you walk onto a car lot and start looking at price tags, you should always mentally add a few thousand dollars to the total amounts you see. The cost might be lower than that, but it’s better to be pleasantly surprised by a total than caught off guard by a bigger number than you expected.
I feel the need to remind people that a lease is just a loan. You might get some nifty incentives like 0% APR for 60 months or no money down at signing, but you’re still driving away with tens of thousands of dollars in debt. You’ll have a new monthly expense and you will lose money in the form of interest once the promotional deals expire. Do not overlook these truths when working on your budget.
Like with a house, more money up front will make future payments easier. Unlike with a house, the value of your vehicle will shoot down like an inverted rocket as soon as you drive away from the dealership. Some people use this as a reason to lease – foregoing ownership of a depreciating asset – but that doesn’t take the debt off your books.
A different, perhaps better option? If you currently have a car that drives relatively well, hang onto it for another year or so. Using the budget that would allow you to lease a new vehicle, set aside money every month into a car fund. Then, when you have somewhere around $5,000 or $10,000, buy a certified used vehicle and save yourself $20,000 over the next five years.
This method might not land you your dream car, but I’m not particularly interested in dream cars. I think the other dreams, like early retirement and awesome family vacations, should be higher priorities. Once you have more money than you know what to do with, spring for that Maserati. While you’re still in the leasing stage, skip the fancier ride.
Should you choose to lease a new car, your budget needs to be prepared for that. Not only will you need to plan your spending further in advance to cover the extended terms, you’ll also have to account for increased insurance premiums. Your lease might come with a good warranty, but anything not under that contract could be pretty pricey.
I don’t want to discourage you from buying a new car… and yet, for some of you, that’s exactly what I want to do. If it takes a lot of effort to make room in your budget for a vehicle, there are probably other expenses you should be more worried about. If you have no choice but to buy a new car because your old one was totaled, don’t use that as an excuse to lease the shiniest vehicle you can find. Set your budget and stick to it, and try with all your might to keep car expenses under 15% of your monthly earnings.
The Golden Rule
The commonality with these three purchases, and any other large expense you might be considering, is that you have to plan ahead. If you buy a house, a car or a college education on a whim, you’re going to be playing catch up for a long time.
Establishing a budget can be tedious at first, especially when you have to account for so many different expenses. Once you get into the swing of things, calculating expenses and figuring out what you can afford becomes quick and easy. At first, it might feel like budgeting doesn’t help your financial situation. Once you give yourself guidelines and start adhering to them, you can do a lot more with your money.
It’s not impossible to buy a new house, or get out of debt, or give your children the education you wish you could have afforded. Being mindful of your spending and setting goals can enable you to make these big purchases. Taking your time and planning ahead may also clarify what’s most important and worth your money.