Can You Afford Your House and Your Car?
For many middle-class American families, the honest answer is, “Not really.”
I’m in the process of preparing a presentation on personal finance that I’ll deliver at a marriage retreat in a few weeks. The thrust of my talk is that, despite hysterical media claims to the contrary, the typical American middle-class family can afford a solid, enjoyable, middle-class lifestyle without burying themselves in credit card debt. They can even—gasp—spend less than they earn and save the difference for retirement and the kids’ college funds.
Who knew?
I still believe this to be true. However, as I researched a batch of statistics on fun and uplifting topics like credit card debt, individual bankruptcies, personal income, and savings rates, a depressing picture of an all-too-typical middle-class American family emerged. I’ll spare you the statistics. And I’m well aware of the fact that one can tell a very different story by manipulating numbers, averages, medians, time periods, etc. Rather than bore you with a deluge of numbers, I’ll give you a quick description of a hypothetical family and their financial situation.
Chris, Beth and their two young children live in the suburbs of Atlanta. Chris makes $70,000 a year as a middle manager, and Beth brings in an additional $30,000 as a customer service representative. Our hypothetical couple bought their house five years ago. Although they had good, financially-sound intentions, their real estate agent convinced them to buy the most house they could possibly afford. Chris drives a 2017 Honda Accord and Beth has a 2018 Honda Pilot. Each was bought new and financed with an auto loan. Fortunately, unlike many of their peers, they don’t have any student loans. But groceries, meals out, clothes, utilities, cell phones, TV, internet, kids’ activities and other recurring monthly expenses eat up the remainder of their monthly take-home pay.
Accordingly, expenses such as family vacations, car and house maintenance, car insurance, life insurance, gifts, medical co-pays and other non-recurring items are essentially financed by credit card debt. Sure, Beth and Chris pay down the balance on the credit cards by a few hundred dollars every now and then. But they usually make only the minimum monthly payments because that’s all they can afford at that time. The aggregate balance on the cards is now about $18,000 and trending upwards. The family has no appreciable savings.
This family is in a financial hole, and they continue to dig. Their spending on discretionary items is on the high side but not grossly so. It’s pretty much in line with that of their friends and neighbors, most of whom are in roughly the same income bracket. If you were to ask Chris and Beth about their spending, they would say use their equally irresponsible peers as comparison points. Chris and Beth would point out, for example, that they don’t throw away money on frivolous items such as furs and jewelry, unlike that financially irresponsible couple who lives down the street.
Our hypothetical Beth and Chris would be very slow to admit that they are in financial trouble. They pay their bills on time, after all. But the bills just seem to get higher and higher each month, and their income isn’t keeping pace. They argue about money, each blaming the other for extravagant spending. They lose sleep over the fact that they have almost no retirement or college savings. They occasionally take a cash advance with one credit card in order to make the minimum payment on another. They wish they could get a big raise, bonus, tax refund, or other financial windfall, which they believe would be the solution to their financial woes.
Chris and Beth are considering a home equity loan and would use the proceeds to pay off their credit cards. Replacing the credit cards and their 18% interest rates with a second mortgage in the 5% range would definitely ease their interest burden. However, this step won’t solve the underlying problem. That problem is absurdly simple: this couple spends more than they make.
As obvious as this statement may be, it never occurs to our hypothetical Beth and Chris. In fact, they have no idea how much money they spend in a typical month. Each of them can tell you to the penny the amount of their monthly take-home pay, but they couldn’t tell you within $500 either way how much they spend. They have no financial plan and no specific spending or savings goals.
Instead, they simply drift along with the crowd, spending $100 for a new pair of shoes here and $40 at the movies there. Because they occasionally decide not to splurge on a big-ticket item, they tell themselves they are financially responsible. After all, our hypothetical family vacationed at Disney last summer, unlike their big-spending friends who spent a week in Europe.
What should Beth and Chris do in this situation? They could certainly dial back their discretionary spending. Clipping a coupon here and there, taking advantage of sales and the like would drop their monthly expenditures by, say, $250. Getting even more radical on the spending front (eating nothing but “beans and rice, rice and beans,” as Dave Ramsey would say) might boost this spending cut to around $500 per month. This $500 per month cut in expenses would certainly be a step in the right direction, but it still won’t be sufficient to dig out of their financial hole.
This is due to the fact that their discretionary monthly spending, while not good, isn’t the main cause of their difficulties. Neither is a lack of income: Chris and Beth earn a very respectable middle-class income. Instead, the main issue is that Chris and Beth bought an upper-class house and drive upper-class cars.
Of course, Chris and Beth would scoff at the notion that they can’t really afford their house or their cars. They’ve never missed a mortgage payment or a car payment, they would say. Never even been late. Additionally, Chris and Beth would dispute the characterization of their house and cars as “upper class.” They don’t drive BMWs or Mercedes, and they don’t live in a mansion. Finally, Chris and Beth would point out that their friends and neighbors live in similar houses and drive similar vehicles while earning similar incomes.
But the sad fact is that Chris and Beth’s peers are likely facing similar financial difficulties to one degree or another. The house-and-car portion of their spending simply eats up too much of their income for them to afford the middle-class, suburban lifestyle that they’ve been living. How should Chris and Beth address the problem?
The first step is to get a clear idea of their spending history over the past year by reviewing credit card statements, bank statements and canceled checks. Chris and Beth should then use this information to create and implement a budget. Oh, horrors! The “B” word! Yes, “budget” is a word with negative connotations; it seems limiting and restrictive and no fun. Some of you will stop reading this piece as soon as you see the word.
If the word “budget” itself is too much of an issue, Chris and Beth can make a “spending plan” instead. They’ll create a written plan detailing how much they’ll spend on gas, groceries, utilities, and other major categories each month. They will then track their spending as they go in order to be sure they spend what they planned but no more. How does this spending plan differ from a budget? It doesn’t. But it sounds better.
You see, no matter what you call it, a well-designed budget/spending plan actually leads to more freedom, not less. It leads to fewer arguments between spouses, not more. With a spending plan, Chris and Beth won’t have to wonder any longer whether or not they can afford to spend $50 on a restaurant meal at the end of the month. If there’s room left in the spending plan, go ahead. If not, not.
The spending plan should include spending levels that are high enough to be realistic yet low enough to create substantial spending reductions when compared to what Chris and Beth have been spending. And, while they’ll need to decrease the amount spent on non-essentials such as vacations and meals out, the spending plan should not completely eliminate fun family activities. Finally, the spending plan should provide Chris and Beth with a small monthly amount (perhaps $50 each) that each spouse can spend on anything without objection from the other. This will provide a small stress-relief outlet for each of them that will be well worth the money.
Unfortunately, creating and implementing the budget/spending plan is the easy part. Let’s assume that our hypothetical couple reviews their spending history and determines—to their great surprise—that they currently spend $12,000 per year more than they earn. Thus, to avoid going further into debt, they’ll need to reduce spending by $12,000 annually, or $1,000 per month. Let’s further assume that the process of creating the spending plan reveals $400 per month in discretionary spending cuts that they can implement, leaving them with a monthly shortfall of $600.
But even conquering this $600 shortfall will only allow them to break even. It won’t be enough to create any leftover cash to pay more than the minimums on their credit cards or to save for emergencies, retirement, or college. Now that they’ve seen the numbers, Chris and Beth are newly determined to solve their financial issues, not just apply a financial Band Aid. Accordingly, their new goal is to have at least $300 left over each month after paying their bills. They want to apply this extra $300 to their credit card balances in order to claw their way out of debt. To reach this goal, they have to find an additional monthly savings of $900 (which consists of the $600 needed to break even plus the $300 desired surplus) over and above the $400 in spending cuts for which they already planned.
Chris and Beth quickly determine that they can’t accomplish this additional $900 monthly savings goal without addressing their car payments and/or their mortgage. What do they do now? Sell something.
Perhaps they sell both cars and buy two very basic, higher-mileage used cars with the proceeds left over from the sale after paying off their car loans. This would eliminate two car payments from their monthly budget. Maybe they sell one car and share the remaining car, thereby eliminating one car payment. Or they could get really radical and sell both cars and buy just one old beater to share.
Whatever they do on the automobile front, Chris and Beth need to learn sooner rather than later that cars are not assets, at least not in the traditional sense of the word. They certainly aren’t good investments: autos decline in value every day. And autos carry ancillary costs such as interest on the car loan, sales tax, tag fees, insurance, gas, and maintenance. In almost every case, the more expensive the car, the higher these ancillary costs.
Yes, Chris and Beth need transportation. But they fell into a trap that snares far too many of us: they bought much more car than necessary to get them from Point A to Point B, and they paid a much higher price than they could afford. They missed the fact that every dollar of a car’s purchase price, taxes, tag, insurance, gas and maintenance over and above what the most basic, least expensive car would cost isn’t really buying transportation. Instead, those additional dollars are the cost of image and status and comfort. Our hypothetical couple doesn’t need image or status (no one does, really), and they can’t afford this much comfort.
Their housing situation is similar to their automobile situation. Chris and Beth bought image, status and comfort in addition to buying basic shelter. And houses, like cars, have ancillary costs such as property taxes, mortgage interest, utilities, insurance, and maintenance that go up along with a larger house and higher purchase price.
Admittedly, unlike cars, houses tend to increase in value over time. But many American homeowners never actually realize a cash return from such increases. Instead, they use the increased value of their current house as an excuse to sell it and buy a bigger, more expensive house. With that bigger house, they get the joy of paying a bigger mortgage, more property taxes, higher utility bills, and the like.
To be sure, moving is a big step. It carries costs such as real estate commissions and moving expenses. For those with school-aged children, school districts are a consideration. And there is real time and effort involved in selling one house and selecting, buying and moving to another. But Chris and Beth should at least consider a move to a less expensive house.
The takeaway from all of this? Like our hypothetical Chris and Beth, many American families:
bought more house than they can afford, especially after factoring in ancillary costs such as property taxes, mortgage interest and utilities;
drive more expensive cars than they need;
have little or no idea of what they typically spend each month;
actually spend more than they earn each year and finance the difference with expensive credit card debt; and
even after implementing a budget/spending plan, would have difficulty cutting their total expenses down to responsible size without reducing their housing and/or automobile costs.
Like many other areas of life, this is a trap that’s easier to avoid on the front end than it is to escape once you’re caught. Accordingly, skip the trip to the car dealership completely and look for a reliable, basic, used car on Craig’s List or, for those of you who are over forty and know what this is, the classifieds. When buying that first house, don’t be too quick to stretch for the McMansion, as there’s nothing wrong with what we used to refer to politely as a “starter house.” And, whatever your stage of life, by all means get a clear idea of your expenses and manage your spending accordingly. You’ll sleep much better as a result.