5 Questions Everyone Should Ask Before Making a Financial Commitment
It’s exciting to look at new cars and houses. Planning a vacation to an exotic island is exhilarating. Even signing up for a magazine that costs $20 per year can be fun, because then you get to look forward to receiving the magazine each month. When we make financial commitments, big or small, we usually do so because we want whatever the commitment is getting us. However, making a financial commitment is a big decision, and directly affects our budgets, and sometimes other aspects of our lives as well. It’s important to take several things into consideration before making a financial commitment. You need to be sure that you can really afford to pay whatever it requires, that the rest of your financial life is in order, and that what you are paying for is truly worth it. Before you agree to your next financial commitment, make sure you consider these five questions.
1. Am I saving enough?
Even if you think you have enough money in your budget to make a particular financial commitment, you should determine if you are saving enough first. Your first priority should usually be to save enough: this means you need to have a sturdy emergency fund, money for retirement, and sometimes a general savings account. If you haven’t established an emergency fund, or you are neglecting your retirement savings, than most other financial commitments should be put aside until your savings is where it should be. Exactly how much you should have to be on track will depend on several things, including what your monthly expenses are, your age and your current salary, and your anticipated medical and other expenses. Just be sure that you really look at your savings before you even consider other financial commitments.
2. Can I truly afford it?
The second question you should ask yourself before you make a financial commitment is whether or not you can actually afford the commitment you are about to make. If you are making a small financial commitment, determining whether or not you can afford it might be easier. Even if you don’t spend exactly the same amount each month, you probably know roughly what you spend. If you want to add a gym membership for $50 per month, and you have the extra money in your budget, then you can afford it. However, bigger financial commitments usually need more consideration. Using a Financial Calculator is a good way to start; you can find one for many big purchases, like a car or mortgage.
3. What will I do if an emergency happens?
This question goes back somewhat to point number one. You need to have an emergency fund established in case you ever have an emergency and you need money quickly. However, before you make a financial commitment, especially an expensive one (like a car, house, trip, etc.) you should have a plan. Determine what you will do in the future if you can’t pay your bills in general, but also determine how the particular commitment you are considering will affect your overall financial health if an emergency arises.
Hopefully you will have an emergency fund, but if you don’t, or it isn’t enough, you will need to find other ways to deal with the emergency. If you are considering a very expensive financial commitment, first consider whether or not you will be able to borrow money, cut down on other regular parts of your budget, or get an emergency loan, if you can’t pay it in the future. Also consider what the repercussions might be: if you are taking out a large loan, what will happen if you default on it? How will it affect your budget, and even your credit score?
4. Is it really worth it?
Yes, new cars are shiny, impressive, and often come with neat extras. However, before you make a financial commitment, you need to consider whether or not what you are paying for is truly worth it. Even if you have money in your budget, if there’s any chance that you will regret your decision later, take more time to think about it. Also consider the other aspects of your life that might be affected by your decision. If you purchase a big house that is also expensive, it might require giving up other important activities or wants that are part of your budget now. The stress of paying for the home, and even the act of maintaining a large home, also might affect you. Just be sure that your commitment is really worth it, and that you truly want it, before you make it.
5. Is this a smart financial decision?
In addition to determining whether or not you can afford something, you should also figure out if your commitment is in your best financial interest. Certain regular payments will increase your credit score, which can help you buy a home or secure a low-interest loan later. However, some financial commitments are risky. If your family member or friend asked you to cosign on a loan, you need to understand that you may never be paid back, and that your relationship with the other person might be damaged in the future if they don’t pay the loan (and your credit score will also be damaged). Also, if you want to invest in a new business, you will financially prosper if the business does well, but again, if it doesn’t, you risk losing all of your money.
Deciding to make a financial commitment is a big decision, regardless of whether or not the commitment is big or small. Before you make your decision, be sure that you answer these five questions. If you are sure that the commitment is truly worth it, that you can afford it, that it won’t damage your finances in the future, and that you will be able to find a solution if an emergency arises, then you can feel more comfortable making the commitment itself.