Do you feel like spending two months' salary on an engagement ring? How about buying a house that requires a mortgage payment equal to 28% of your gross monthly income?
Those are two of the most common formulas that consumers have used to judge how much to spend on key life purchases. But here's the truth: There is no one-size-fits-all strategy to determine how much you should spend on a new car, house, or engagement ring. The amount you should spend on any of these three big buys depends on your specific finances and goals.
Assess Your Finances
"It's key to look at your entire financial plan and to budget appropriately within your means so that one purchase does not derail your long-term goals," saysDavid Mirabito, a financial advisor with the MetLife Premier Client Group in Syracuse, New York. "It's a balance between financial wants and needs."
If you have plenty of savings, are paying your bills on time each month, and aren't burdened with much debt, you can buy an engagement ring that costs six months' salary if it makes you and your partner happy. But if you're struggling to pay the bills each month? You might not want to spend even two months' salary on an engagement ring.
Avoid Overpriced Weddings and Bling
Who says you need to spend two months of salary on an engagement ring? The diamond industry, that's who.
It's no surprise that De Beers wants you to cough up thousands of dollars on a diamond ring. But that might not be realistic for many young people who are ready to get married. Young people face plenty of other expenses. Edvisors reports that the average class of 2015 college graduate will leave school with more than $35,000 in student loan debt. And weddings themselves are getting increasingly expensive, with wedding website The Knot's 2014 Real Weddings survey reporting that the average couple spends $31,213 on a wedding. (Though why so many spend so much for a one-day event is a good question.)
Adding $8,000 or more to pay for an engagement ring might not seem like a sound investment to consumers facing so many other big bills. Again, though, there is no real rule here. The key is to spend according to your budget. If you can't afford an expensive engagement ring now, there is no shame in spending less today and eventually trading up as your finances stabilize. Putting the cost of an expensive engagement ring on your credit card might make that piece of bling less attractive.
Choose a Realistic Mortgage
You're ready to buy a home. How much should you spend on it? Most mortgage lenders recommend that your new monthly mortgage payment equal no more than 28% of your gross monthly income — that's your income before taxes are taken out. But be sure to include all of the components of your monthly housing payment when determining how much your loan will cost you each month. Your mortgage will usually include your principal payment, interest payment, insurance fee, and property taxes. That's the standard PITI formula — principal, interest, taxes, and insurance.
This doesn't mean that your mortgage payment has to be 28% of your gross monthly income. You might feel more comfortable if your housing payment comes out to 25% or 20% of your gross monthly income each month.
Go with what makes you feel comfortable. Struggling to pay your mortgage each month can make owning a home feel more like a burden than a joy. Remember, too, that big purchases — such as a house — always come with big expenses in the future.
"The cost of most major purchases is not the full cost of the item," says Kevin Gallegos, vice president of Phoenix operations for Freedom Financial Network. "In the case of a home, a down payment is only the beginning. There are costs for home insurance and taxes, private mortgage insurance, and ongoing upkeep and maintenance. For a car, routine and periodic maintenance can add up substantially. If an engagement ring is in the picture, there will be a wedding of some type, possibly a honeymoon, and other marriage-related costs. Before making a purchase, calculate the real costs of buying, now and into the future."
Buy Only as Much Car as You Need
Cars certainly aren't getting cheaper. According to the Kelley Blue Book, the average price that consumers paid for new cars in June of this year hit $33,340. That figure is on an upward trend, a boost of $209 from the previous month.
How much should you spend on a new car? One standard is that your monthly car costs — which includes not just the size of your monthly auto loan payment but the costs of insurance, maintenance, and gas — should equal no more than 15% of your net monthly pay. Another potential guideline? Some recommend that the price of any car you buy should never equal more than half of your yearly income.
Again, these are rough guidelines. If you're struggling to pay down high-interest rate credit card debt, it might not make sense to add a big monthly car payment to your expenses. You might want to follow another long-term guideline here: Make sure that your total recurring monthly expenses are no more than 36% of your gross monthly income. Buying a less expensive car might be a better financial move.
"Ask yourself, especially at a young age, 'How important is it that I have the latest and greatest gizmo in my car?'" said Mirabito.
This article first appeared at Wise Bread.