Weigh all options when financing expensive purchases

Credit cards aren't typically the right choice for long-term financing

By Erica Sandberg

Opening Credits

Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." Ask a question. 'Opening Credits' stories

Dear Opening Credits,
I work and make about $450 a month. I'm getting ready to turn 18, and I really want a motorcycle. I can make a $200 payment each month; I just do not have credit. I would like a $12,000 card. I won't spend it all, but I would spend about $8,000. What do I do? Should I just give up on a dream? -- Phillip

Dear Phillip,
It is certainly not my place -- or anyone else's -- to tell you to abandon a dream. And as a former motorcycle rider and owner, I can appreciate the desire to get a really sweet bike from the get-go. However, you're talking about a major purchase and one that your credit history and income plainly can't support at this time.

From your letter, I gather that you would like to buy this super bike with a credit card; yet charging such an expensive item is foolhardy. Credit cards are not intended as tools for long-term financing, the primary reason being that spreading payments over many years will increase the price of the bike dramatically. For example, let's say you did borrow $8,000:

• Scenario A is with a credit card. The minimum payment is 2.5 percent of the balance (roughly $200 in the beginning, which is just about what you say you can afford right now), and the interest rate is 18 percent
• Scenario B is with a loan from a bank or finance company. It has a fixed monthly payment of $250 (slightly out of your range but a typical sum for such a loan amount), and the interest rate is 8 percent.

Still want to put that motorcycle on plastic? No? I didn't think so.

This doesn't mean that you should just opt for a bus pass. Options exist. For instance, you can save your money and pay for the motorcycle in full with no finance charges being added at all. Because your wage is low, though, this would take a long time. Therefore, you may consider saving enough for a substantial down payment -- say, a couple of thousand of dollars -- and financing the rest. This way, you would borrow less and could also qualify for a better interest rate, factors which would drive the monthly payment and total cost down to an affordable level. Other possibilities include buying a less expensive vehicle or getting the model you want used rather than new.

Clearly, there are ways to get a bike, but before you even attempt to buy, I strongly recommend that you become familiar with the basics of personal economics first. Here are four rules of the money game specific to your situation:

1. Build your credit. Get a secured credit card with a low limit, then borrow and repay responsibly. I understand that you want a credit card with a $12,000 limit, but I'm afraid that is not realistic. Credit card issuers want to be as sure as possible that their customers will repay what they borrow. With your salary and absence of credit history, you are highly unlikely to qualify for such a line of credit.
2. Live within your means. However much or little you earn, expenses must always be less than your income. Monitor your spending habits closely. With just $450 coming in, even if you're living at home with few bills to cover, everyday costs can quickly absorb that sum.
3. Make money. If you want to buy a lot, earn a lot. Focus on gaining the skills and education necessary to prepare you for an enjoyable and well-compensated position.
4. Plan for the future. Whatever you do, never spend every incoming penny. Instead, make a habit of saving and investing at least 10 percent of your net income.

The fabulous thing about being a young adult, Phillip, is that you are in an ideal position to learn how to borrow and spend intelligently before making some very costly mistakes. When you're finally riding, you'll discover plenty of destination shortcuts, but know this -- the road is pretty straight when it comes to finances.

See related: 8 tips to keep credit card rates and fees low, Lending standards keep tightening, Fed says

Erica Sandberg's articles and insight are featured in such publications as the Wall Street Journal, Pregnancy, Babytalk, Redbook, Bank Investment Consultant, Prosper.com, MSNMoney.com, and Smartmoney.com. An active television and radio commentator, Erica is the credit and money management expert for San Francisco’s KRON-TV, a frequent guest on Forbes Video Network, Fox Business News, Businessweek-TV, and all Bay Area networks. Prior to launching her own reporting and consulting business, she was affiliated with Consumer Credit Counseling Services of San Francisco where she counseled individuals, conducted educational workshops, and led the media relations department. Erica is a member of the Society of American Business Editors and Writers, and on the advisory committee for Project Money.

Send your question to Erica.

Published: May 20, 2009

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