Hey everyone! In today’s post I explore five potentially dangerous financial commitments many of us are confronted with at some point during our lives. While I’ve summarized them below, I will take a closer look at each one in the coming weeks. Enjoy!
I made a relatively small, (yet somewhat difficult for me) financial commitment this month. A no-spend January! The experience has inspired a lot of thought about the bigger commitments we make in life. Things like work, marriage, kids, faith, and you guessed it, finances!
When it comes to the places where you commit your hard earned dollars, there are the no-brainers. Savings plans, insurance, education, debt repayment or charitable giving, it’s hard to go wrong with this stuff, although there are more or less effective ways to do so.
On the flip side however, there are the not-so-easy financial decisions. These are the ones that can jump out and bite us if we’re not careful. Have you ever been told, “Be careful what what you commit to”? That advice couldn’t be more true when it comes to your money.
As such, I think it’s important to shine a spotlight on a few of life’s potentially dangerous financial commitments. Before we get to the list, here’s something to consider:
Choose your financial commitments wisely:
If anyone tells you they’ve never made mistakes with money, they’re out to lunch! Every one of us have, I know I certainly have. After all, managing money is tough! There are always unknowns, and our emotions can get in the way. Not to mention, we don’t always have hindsight to guide us.
So proceed with caution, especially with the big decisions; major purchases and long term commitments. While I’m a firm believer that most financial mistakes can be corrected, certain ones are more difficult to reverse, taking more time and causing more collateral damage. It’s always a good idea to seek the counsel of someone you trust. If you notice that your emotions are clouding your decision making ability, a third party can help guide you to a more rational decision.
Without further ado, here is my list of five potentially dangerous financial commitments:
1. Taking out a MONSTER mortgage.
A house is the biggest purchase most people will ever make, and a huge financial commitment. This is especially true if you’ve stretched your borrowing capacity to the limit by taking out a MONSTER mortgage, and purchased more house than you can afford.
One problem is that too many people don’t think long term when they buy a house.
A lot can change in your life in 5, or even 10 years. There’s a reason a house is considered a fixed asset. It’s not easily liquidated if you experience a sudden change to your financial situation, or your plans.
Things like rising interest rates, or declining housing markets can compound the risks of taking out a large mortgage.
But the bank says I can afford it!
Just because your bank will qualify you for a mortgage payment of up to 32-35% of your pre-tax income, does not mean you should even approach that figure.
One problem is that the calculation is too simple.
Did you know that your bank uses the EXACT SAME measuring stick of affordability for an individual that they use to qualify a family of two parents with three or four kids? The living expenses incurred by different borrowers can vary greatly!
Furthermore, banks rarely take into account the various lifestyle expectations and savings commitments of their customers when qualifying them for a mortgage, or any credit for that matter.
No wonder so many people have trouble finding the money to save at the end of the month.
2. Financing a new car.
Let me make this clear, buying a new car is NEVER a great investment. This is coming from someone who bought a new car, and then, 14 years later, wrote a post titled “The Greatest Car I’ve Ever Owned”! Makes me sound like a hypocrite, right? If you ask me, that article should have come with a disclaimer, stating “results are not typical”, like some gimmicky weight loss infomercial. For a new car purchase not to be a poor financial decision, there are simply too many factors that have to go right.
You need to own it for well over 10 years, drive it a gazillion miles, while it returns rock-solid reliability to you during the life of the relationship. How often do all of those things really happen? Most people don’t hang on to their cars that long, getting rid of them shortly after they’ve endured their vehicle’s sharpest period of depreciation.
The other problem is that for every $16,000 Toyota Corolla or Honda Fit, people are buying $50,000 Ford F-150’s. This is where buying a new car goes from a questionable decision to a complete disaster.
3. Retail store financing programs.
While the dollar amounts involved don’t compare to buying a new car or an expensive home, taking advantage of seemingly attractive financing offers from retail stores is rife with potential hazards.
I’m referring to the “Don’t pay a dime until 2029”, or “No interest or payments until 2018” offers, when you buy household items with a retail store credit card. They make it so easy to get that new living room set, or the stainless steel kitchen appliances. The truth is, it’s so easy to for things to go awry, leaving you with a huge credit card bill and sky high interest rates when the grace period expires.
When it does, are you 100% sure that you’ll have the funds available to pay the amount in full? Many of these programs will charge interest at the full rate, retroactive to the date of purchase, if you miss the payout deadline by even one day!
My advice for the vast majority of people? Don’t touch retail store credit cards. Think of it as the financial equivalent of handling a ten foot long venomous snake, or allowing a black widow spider to crawl across your forehead. : )
4. Co-signing a loan for a friend/family member.
Here’s one you don’t read about a whole lot in the personal finance community, which surprises me. Anytime you decide to co-sign for someone else’s credit, you are making a huge financial commitment, with numerous potential pitfalls.
This is an area where emotions and money can collide, with disastrous results! If things go wrong, much more than your credit rating can be affected. Close friend or family relationships can be damaged.
It doesn’t matter that you’re in a great financial position, that you’ve been blessed with a stable job, or that you’ve got net worth to burn.
By becoming a co-signor, you are now financially “joined-at-the-hip” to someone who may not be as wise or as committed as you are, about money. The fact that they need you to come along and add strength to their credit application means that while they may have noble intentions, their bank has reservations about their ability to repay the loan.
Here’s a rule to follow: If you wouldn’t be willing to give this person the loan amount in the form of a gift right out of your pocket, you probably shouldn’t take on the responsibility.
One other thing, you may be told that cosigning is just a temporary arrangement. “We’ll get you off this thing in 6 months or a year!”. Yeah right. Remember this: Banks are usually VERY reluctant to remove co-signors from a loan prior to full repayment. After all, what’s their motivation to do so? Their priority is managing risk, not doing favors.
I have one more point to add, and it’s an important one. When you are applying for your own credit, the monthly payment on any loans you’ve cosigned for must be included when the bank is determining your own affordability. No consideration is given to the fact that someone else makes the payment each month.
5. Starting a Small Business.
Woah, hold on! As a personal finance blogger, I should be supportive of things like having an entrepreneurial mindset, taking control of your finances, of side hustles and breaking from the 9-5!
Unfortunately, an entrepreneurial mindset alone won’t do it for you. In fact, on it’s own it could be very dangerous. In my experience, one of the strengths of a born entrepreneur is the willingness to take risks. However, if you don’t possess the other qualities necessary to be successful in business such as talent in your field, collaborative ability, unmatched determination and really thick skin, you’re in big trouble.
I’m not saying don’t start a business. In fact, I’ve begun the journey of converting my side hustles into a regular income stream myself.
But be wary. Understand the risks. Do your research, and draw on the advice of people that have the knowledge and experience to help guide you!
There you have it! Five of the most dangerous financial commitments you can make.
This is far from an exhaustive list. What others can you think of?
Feel free to send me an email or share in the comments below!