5 questions to ask before you take on debt
So you’re standing in the local auto dealer’s lot, trying to decide if you should buy the new $50,000 car or the used one for $20,000. You’ve kicked the tires and done the math and know you’d need a car loan for the more expensive one.
Now you’re wondering How much should I spend on a car? And, even more important, Should I take on more debt? Taking on more than you can handle will affect how much you can save and invest for the future. Avoid overextending so you don’t put your long-term dreams and goals at risk.
Whether you’re paying for a car, or a refrigerator, or a new pair of skis, here are 5 questions to think through before you take on debt.
1. Do I need to buy this, or do I just want it?
This is your ultimate question. If your house has a leaky roof to replace, that’s a need. A roof is kind of important. More important than, say, putting a big screen TV in every room. That’s a want.
2. How long would it take to save and pay cash instead?
It can take a long time to save enough cash for a car. A car loan may be necessary. But if you want a weekend getaway to Las Vegas, you could probably save for that before you go, using cash to cover your expenses.
3. Can I afford this debt?
Consider whether it affects your ability to put money away for emergency expenses. If you can’t build extra savings, you may go further into debt when life throws a curveball. Also look at how it changes your debt-to-income ratio, which could affect your ability to get credit when you really need it. (Tip: Google “debt to income ratio calculator” and plug in your numbers to see where you stand.)
4. Do other lenders have better interest rates or terms?
It pays to shop around because it can save you money. Do your interest rate shopping before you step foot on the car lot, for example. Otherwise, you may take whatever loan the dealership offers. Who knows? You may find a better car loan on your own.
5. Am I buying something that will increase in value?
A home mortgage or home equity loan can be a good debt. Chances are, in most geographic markets, your home will rise in value over time. Meaning, it can be a good return on your investment. Compare that to the new phone you want … to replace the one you just bought a year ago. It’s not increasing in value. (See number 2 above. Can you save your money and pay cash instead?)
- Start all debt considerations by asking Can I still save and invest money if I make this purchase?
- Decide if you can trim expenses to pay down debt by using our budgeting worksheet (PDF).
- Request your free copy of your credit report so you know how it may affect your ability to borrow.
- Create a plan in 7 days to start chipping away at your debt.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
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Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, IA 50392.