Approved Is Not the Same as Afford
If I were to say, “Don’t max out all your credit cards because you will go broke!” most people would respond, “What’s your point? Everybody knows that.” Well, did you know that common sense is no longer common? Actually, most people get it… when it comes to credit cards, but not so much when it comes to loans.
When a lender such as a bank approves you for a certain amount of money, they are telling you the absolute maximum they are willing to lend to you. Think about that for a moment. That is the maximum they are willing to lend you. Now, you may think that if they are willing to lend it, then they must think you can afford it, and since this is what they do for a living, they must know better than you, right?
Wrong… for a few reasons. First, the lender is likely paid commission or must reach certain sales goals. That means they only make money if you get a loan – and they make more money if you take out a bigger loan. So they want to let you know the most they can lend you. Second, they don’t care about your lifestyle, your goals, or your social life. Since not everyone dines out five days per week, or buys coffee everyday or takes vacations or send their kids to Math Camp, or… Well you get the point. Since not everyone does these things, they assume if you are willing to borrow the maximum then you must be willing to give up all of these other luxuries. If you are only willing to give up one or two luxuries then you should borrow less than the maximum.
So how do you know how much you should borrow if you can’t go by what the bank says? You have to review your budget! Lenders do not sit down with you and go through your budget and your goals and your future plans with your partner or family. They simply run some percentages looking at your income, your job stability, your net worth, what you are using the money for, and your credit score. Then they simply let you know the maximum amount you can borrow. That has nothing to do with what you can afford based on the other things in your life where you like spending (fun stuff), saving (college tuition?), or investing (retirement?) money.
What to do? Look at your income and your spending, with your long-term goals in mind, and determine how much you are able to and willing to give up to get that loan. That is how much you should borrow. No more. Otherwise you may have to sell something… like your car, or your child’s future.