So here’s the story.
I need a new car. The details aren’t important but my car is getting up there in miles and is starting to need some major repairs. The transmission slips when it’s wet or cold and there’s a weird vibration in the front end. So last week when I took it in for some routine maintenance I went up front and talked to the sales team about what it would take to get me into a new(er) vehicle.
I’m not wealthy by any stretch of the imagination. I work hard and I am projecting some solid growth in my business over the next few years but I’m not wealthy. Nevertheless the bank approved me for a monthly payment of $700 on an 84 month term. Think about that for a minute. That’s $8400 a year for 7 years or $58,800. Working backwards, after financing costs that’s almost $40,000 for a guy who barely makes $50,000 a year, when the finance manager at the car dealership told me that I literally laughed in his face. That’s just nuts!
Financing is function of ratios. Most bankers will tell you that no one should pay more than 35% of their net income servicing debt, mortgages included. Personally I think the real number should be closer to 25% for the average person and as close to zero as possible the lower your income. $8400 a year is 26% of my net income, not to mention the rest of my debt and lifestyle choices. There is simply no way I can afford $700 per month on anything, let alone a depreciating asset like a car. Quite frankly the banker who approved this must be on crack.
Last week it was widely reported that the average Canadian household is 163% in debt. That means that for every dollar we make we owe $1.63. Everyone agrees this is crazy and yet not two days later I get approved for a loan that would throw my budget completely off the rails.
The economy is built on credit. People need to spend money so that others can make money. That’s a given and sometimes we need help and incentives to buy large ticket items. But when we are given the ability to spend beyond our means we are building a house of cards. One minor interest rate shock and the whole thing will come crashing down. We only need to look as far back as 2008 and the United States housing bubble to see what can happen to average people in that event.
At the end of the day I bought a car for about half of what that bank says I can afford and because I hate being in debt I’m going to pay it off about twice as fast as they want me to. When the economy collapses under the weight of all this ridiculous debt I’ll be debt free again and the bankers who tried to bury me will likely be unemployed.
My advice to anyone considering a major purchase; only you know what your budget can bare, stick to your guns and don’t let the bankers and sales people seduce you into something that you may live to regret.