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How to Determine If Your Finances Are Ready for a Big Purchase

How to Determine If Your Finances Are Ready for a Big Purchase

October 18, 2017

Maybe you're ready to make an offer on that dream home down the street. Maybe you're eying a new car for that long commute to work. Or, maybe you just want to plunk down a few thousand dollars on a fancy vacation or the latest gadget. How do you know that you're financially ready to make such a large purchase?

Whatever it is that you want to buy won't bring you any joy if you can't actually afford it. Here are some questions you need to ask yourself to make sure you're financially ready to commit to a big purchase.

Do you already pay all your bills on time?

If you're taking out a loan for a large purchase such as a house or car, first look at how you pay the rest of your bills. Do you routinely pay your credit card bill three weeks late? How about your utilities or cellphone bill?

If that's the case, you're not ready for the financial responsibility of another large monthly payment. If you're already struggling to pay your bills on time, adding another even larger bill to your financial responsibilities will only put you at a higher risk of accumulating debt.

You can hurt your credit score doing this, too. If you're late on the monthly payments for a house or car by 30 days or more, your score will tumble. If you struggle enough to pay those big payments on time, you might even lose the house or car altogether.

Protect yourself financially by holding off on that big purchase until you've already developed the habit of paying all your other monthly bills on time. 

How much wiggle room is left in your budget?

Before making any big purchase, it's important to check your household budget. Make sure you have the ability to make the monthly payments comfortably while leaving enough money to cover your other monthly expenses.

And if you don't have a budget, you absolutely need to make one. How else will you know if you can afford your new purchase to begin with? Making a budget isn't as intimidating as it sounds. First, list all your recurring expenses each month. Then estimate how much you spend each month on discretionary and non-fixed expenses such as entertainment, groceries, and eating out. Finally, list your monthly income. The difference is how much you can afford to spend on new purchases and save each month. 

How strong is your credit?

Before taking out a loan for a new car, home, or other big purchase, make sure to check your credit. Lenders rely on your credit score to determine if you qualify for loans and, if you do, how high of an interest rate they'll charge. Lenders consider credit scores of 740 or higher to be strong ones. Generally, the lower your credit score, the higher your interest rate on loans. The higher the interest rate, the more paying off that big purchase will cost you over time.

You can check your credit reports — a list of your outstanding loans, how much you owe on credit cards, and whether you have any late payments or other financial blemishes in your past — by visiting AnnualCreditReport.com. At this site, you can order one free copy of each of your three credit reports (from Experian, Equifax, and TransUnion) every year. It's important to make sure that there are no errors on your credit reports and that the bureaus don't have any late payments or other financial black marks listed against you. These reports, though, don't contain your credit score. You can order your score for a small fee from any of the bureaus.

Before making a purchase big enough to warrant a loan, you might want to check your credit score to determine if you'll be saddled with high interest rates. A score under 640 will almost always leave you with a sky-high rate. 

How much credit card debt do you have?

Credit card debt is among the worst kind of debt to have. Interest rates can be as high as 16 percent, 18 percent, or even higher. If you carry a balance on your cards each month, your credit card debt grows quickly.

If you are struggling to pay down your credit cards, resist the temptation to spend big on electronics, furniture, or other items. Instead, devote that money to paying down your debt. And if you can only make that big purchase by putting it on one of your credit cards, don't pull the trigger. You will only dig yourself deeper into a hole. 

Can you cover the maintenance expenses?

Sometimes buying an expensive item is only the start of how much you'll actually pay for it in the long run. Many big-ticket items come with high yearly maintenance expenses. Consider a house, for example: Sure, you'll spend a lot of money upfront to buy one. But you can also expect to spend 1 percent of your home's purchase price on maintenance each year. 

If you can't afford to maintain your big purchase, hold off until you can create more wiggle room in your budget.