Tarek has been watching money-guru YouTube videos. Some of these gurus have been forecasting a major decline in the economy which might lead to job insecurity. As a result, they're recommending that people should avoid debt at all costs and instead buy what they need.
Tarek would like to follow this approach when managing his own financial affairs, but there are a few problems. First, Tarek's car recently broke down, and the repairs will cost much more than the car is worth. He now needs a new vehicle. Unfortunately, Tarek's emergency fund is not fully established, and he doesn't have the cash to buy anything that would be both safe and reliable. He has another problem: When he was in college, he had a credit card and sometimes made late payments. Although he eventually paid off the credit card and cancelled it, his credit score is still on the low end of the FICO score range.
Instructions:
Tarek has come back to you with a few more personal finance questions. Help Tarek work through his questions and issues by providing advice that will help set him on the right financial path.
a. When thinking about purchasing a car, Tarek came up with the following estimates. First, he's confident that he can dedicate $410 per month for the purchase and maintenance of a car. Tarek also estimated the following monthly expenses: gas $50, insurance $80, maintenance $40, and repairs $15 (assuming he buys a new car). Based on these estimates, how much can Tarek spend each month on a loan payment and what is the maximum loan amount he will receive, assuming a 4-year, 3% APR loan?
b. Assuming that Tarek can obtain a car loan, how will making timely payments influence his credit score? What other things can Tarek do to reestablish his credit score?
c. Not surprisingly, Tarek still has several thousand dollars in student loans outstanding. When he graduated from college, he had federal loans of $45,000, with an average APR of 6.80%. Six months after graduation, he started making payments using the standard repayment plan. How much is his monthly payment? If all his student loans were subsidized and if he wants to minimize his monthly payment to increase his financial flexibility, what repayment schedule would be best for Tarek? What will be his new maximum monthly payment if his federally calculated discretionary income is $4,500 per month?
d. Because housing prices in his area have recently dropped, Tarek is convinced that he should buy a home. Given his projected monthly income of $4,500 and other monthly debt repayment expenses of $225 for a car and estimated student loan payments of $500 per month (use this number rather than the number calculated for part c), what is the maximum monthly principal plus interest payment he can afford if insurance is $80 per month and property taxes on the home are an additional $200 per month (use HUD guidelines)? What size mortgage can Tarek afford based on your answer, assuming that he can obtain a 5.50% loan for 30 years?
e. Now that you've helped Tarek, do you think that he should follow the money gurus' advice and avoid debt at all costs, or should he incorporate credit and debt into his financial management strategy? Why or why not? What other factors might be considered when he makes his final decision?
