Transportation decisions shouldn’t be an afterthought.
Two years ago, I came across a young married couple that was struggling financially. Tyler and Monique were suburbanites who had been married for about four years and lived in a house with a mortgage they could barely afford. Whereas I prefer that people keep their monthly mortgage payment around 25 percent of take-home pay, theirs hovered around 34 percent. They were unsurprisingly stressed.
But it was their transportation budget that had them in trouble. Tyler and Monique were spending 23 percent of their income on getting to and from work.
Amongst all the tricky spending categories, you’ll find transportation costs. Car payments, car insurance and gas may seem financially innocuous, but they’re anything but. There are more ways to screw up your financial life with poor transportation cost decisions than just about any other spending category. You can buy the wrong car, pay too much for it, finance it the wrong way and then pick the wrong company to insure it. All the while, you are trying to keep your final monthly expenditure under the prescribed 15 percent of your monthly take-home pay. A poor car buying (or leasing) decision can leave you in the lurch for years.
Staying under budget can be challenging, especially if you have two car payments, as was the case with Tyler and Monique. To compound their issues Tyler had owed more money on his previous car than it was worth and decided to trade it in anyway. Therefore, he did something very common, yet very dangerous. He financed negative equity. In other words, he rolled his old loan into his new car loan, and essentially paid $34,000 for a $28,000 car.
I’ve noticed that once a person starts down this borrowing decision path, they stay on this path for at least two cars. While a car dealer may present this process as a solution to a transportation problem, it creates a whole other set of problems. So a good solution, it is not.
In a perfect world, you’d have no car payments. I’ve personally enjoyed this phenomenon for years now, and I can tell you, there’s nothing better. Yet, as crazy as this sounds, always having a car payment might be the solution to a transportation budget issue. Going over your 15 percent transportation budget can create a major cash-flow crunch that hinders your ability to make financial progress in the other areas of your life. And while it may seem to make sense to temporarily bite the bullet on a higher monthly payment to eventually alleviate this expense, often times, it does not.
If a consumer is struggling with other forms of debt, is paying too much for housing, and/or paying out the ear for day care, then finding a very inexpensive lease might be the best financial decision. Yes, despite what you’ve heard, a car lease might actually save the financial day.
A car lease can make sense if you’re in a cash-flow crunch. Preferably, if you’re in a cash-flow crunch, you’d just buy a very cheap car for cash, but sometimes that isn’t an option. And while I realize that leasing a car isn’t technically great personal finance advice, it it very practical personal finance advice. And the reality is that if you’re in a big cash-flow crunch, then you haven’t shown the greatest propensity to handle technical personal finance decisions, so some practical real world advice is warranted.
If you choose to lease, then make sure that you aggressively clean up your financial life during the term of the lease. If it’s a three-year lease, then you’ve got three years to clean up debt, tighten down spending issues, and build cash reserves.
The goal in all of this is to make sure that you’re not spending more than 15 percent of your income on transportation costs (car payments, fuel and insurance). Feel free to ignore this advice, but don’t come to me when you’re honked off.