- Articulate how to buy a home and other major purchases
Buying a Car
Some people have the means to buy a car for cash, so don’t assume you have to borrow to buy a car. Some people make monthly payments into a savings or investment account so that when it comes time to buy the next car, there is cash for the purchase.
However, most people get loans for a good portion of a major purchase like an automobile. When you are ready to buy your next (or first) car, you should take a good look at the pros and cons of buying new vs. buying used.
A new car will likely be more reliable than a used one, even though pre-owned cars are much more dependable than they used to be. If a new car breaks down, you can have it fixed for free under the included factory warranty—typically manufactures offer a warranty for the first 36,000 miles or three years.
Automakers offer attractive car-buying incentives, and new car loans usually have better interest rates than used car loans. Dealers offer plenty of incentives to lure buyers, such as cash rebates. In addition, a new car will have the latest technology, comfort, performance, and safety innovations.
Despite all those reasons to buy a new car, there is one glaring reason to avoid new cars if possible. It’s an economic term we use in accounting (although we define it slightly differently there) called depreciation.
Economic depreciation is defined as loss of value. The cold, hard truth is that if you bought a brand new car at the sticker price (dealers usually don’t haggle over price as much with a new car), drove it off the lot and then tried to sell it again a few days later, you’d be lucky to get 70% of your purchase price.
It used to be that buying a used car was quite a gamble, but newer used cars (say, less than 5 years old) can deliver more than 100,000 miles before needing major repairs. All cars require regular maintenance such as oil changes, tire rotation, brake jobs (so be sure to build that into your monthly budget), but you can drive today’s cars much farther in between these scheduled maintenance visits. Even tires and brake pads last much longer than before. Besides, insurance rates may be lower on a used car, and you’ll be less worried about that first ding in the paint.
In short, your best bet may be to buy a car that is three to five years old with low mileage, balancing the advantages of a new car with the advantages of a used one.
Unlike a credit card, which is considered unsecured financing, a car loan is secured, which means that the vehicle is pledged, by you, as collateral for the loan. That means if you default (stop making payments), the lender will send someone to your house to repossess the car. The lender will then sell the car at an auction, usually for a really low price, and you’ll still be on the hook for whatever balance of the loan the auction proceeds don’t cover. A repossession will also significantly harm your credit rating.
Buying a House
The other major life purchase you might make that will require secured financing is your home. A traditional home mortgage is usually 80% of the value of the home, requiring you to come up with the other 20% as a down payment, although there are some low down payment programs backed by the Federal Housing Administration (FHA) or the Veterans Administration (VA) or other government agencies. It’s important to make sure you don’t get in over your head and become “house poor,” meaning too much of your monthly take-home pay is being spent on housing. It’s easy to do. The best thing you can do to avoid getting in too deep is to shop around and to make sure you remove as much emotion from the purchase as you can—don’t tour houses out of your price range; it’s all too easy to fall in love and make poor financial decisions. Buy well within your means, even if it means settling for a small house in a less-prestigious neighborhood. You’ll be happier in the long run.
The good news is that unlike cars, which tend to decline in value quite rapidly, real estate (both the house and the land) tend to go up in value. A lot of people choose to buy a “starter home”—a smaller house, most likely not in their dream neighborhood. Let’s say Erik and Alex bought a little starter home together for $200,000 with a down payment of around $40,000. In five or six years, their house’s value may have gone up to $230,000, adding $30,000 in equity. If they find it’s time to move, they can use that equity as a down-payment on their next house.
A House as a Liability
Some financial experts consider major purchases, like a car and a house, as liabilities, not assets. As you will learn in accounting, assets, in the business sense, are resources that we own that produce revenue. So, an automobile used in a business, such as Uber or Lyft, would be an income-producing asset. You may need your vehicle to get back and forth to work, but still, you have to pay insurance, fuel, repairs and maintenance, and the monthly payment, if you have one. It pays, in the long run, to buy smart—don’t overspend and become car-poor, or house-poor.
A House as an Asset
A home can be an asset. When you retire, the equity in your home may be a resource you can tap into to pay expenses. Equity is simply the difference between what the home is worth and what you owe the bank. Many retirees sell the home they bought many years earlier and use the proceeds to fund travel or assisted care, and they move into a smaller home. Still, during your life, remember that, like an automobile, you will have expenses in maintaining and paying for a home, such as insurance, property taxes, painting, a new roof, plumbing repairs, yard work, aesthetic improvements, replacing the carpet or other flooring, and so on. Don’t forget to take these expenses into account as you plan to purchase your home.