Dave Ramsey says the easiest way to know if you can afford something is with this simple formula

Deciding whether you can afford to make a purchase can sometimes feel complicated, but if you listen to Dave Ramsey, it doesn’t have to be. Ramsey has a very simple rule that will allow you to know in an instant if a purchase is one you should make or if it would be a money mistake. Here’s what Ramsey said. 

“If you can’t pay for it, in cash, in total, on the spot, cash on the barrel head, you can’t afford it — whatever it is.”

So, is he right? Is that the only rule you need to know in order to make your buying choices?

There’s a lot of merits to Ramsey’s position

Ramsey’s words of advice make a lot of sense in most situations. The reality is that borrowing to buy stuff impacts your future financial security, makes all of your purchases more expensive, and makes it harder to live within your means going forward.

Say you take on debt for something like furniture or a vacation or an appliance. You’ve made that item cost more than it would have had you paid cash since you are paying interest on the purchase. All the money you are devoting to interest is money you cannot use for other things so you have less to save for retirement or even just to cover the bills. 

Since you are committing to monthly payments, you are also promising future income you haven’t even earned yet. So, when you get your paychecks in the coming years, some of that money immediately goes to past purchases. You have less to spend on today’s needs or on saving for tomorrow’s needs, so you increase the chances. you’ll have to borrow again. 

Avoiding all of this can make you a lot richer, so there’s a lot of merit to sticking with Dave’s simple rule and just not buying anything you can’t pay for outright. 

There are some exceptions though

While Ramsey’s rule makes sense for most things, there are times when borrowing actually is a good option.

For example, most people can’t afford to just buy a home outright — and they probably shouldn’t, since the ROI from investing is usually higher than the interest savings you get from not paying a mortgage. Owning a home can often increase your net worth over time since mortgage payments help you build equity. Many people also can’t afford to buy a car outright and, while you should try to save up for a vehicle instead of taking a car loan, that’s not going to be practical if you need a vehicle to get to work now and you don’t have one. 

Ultimately, it makes sense to borrow for truly important things that are essential to living your life and growing your net worth. Even in these situations, you would want to limit the size of the loan and borrow as little as you can to accomplish your goals, and you would also want to make sure to shop around to get the best and most affordable interest rate so borrowing costs as little as possible. 

When it comes to things that aren’t essentials, though, stick with what Ramsey said, start saving in a high-yield savings account for the items you want, and wait until you can pay for them outright before you pull the trigger.