Have you ever wondered who you’re borrowing money off when you go into debt? If you think you’re being given money by a bank or credit card company, think again.
In this post I will explain in one sentence who is really lending you money when you borrow.
The rest of the article will explain why it costs you more than you might think to take it.
Borrow now, and have less later
Loans, mortgages and credit cards are mechanisms by which you can borrow money. They don’t give you a dollar to spend.
So where does the money come from?
When you borrow money, you’re borrowing from your future self.
Loans and credit cards turn the impossible into reality, taking money you’ll have in the future and giving it to you today. It’s an almost magical process that clouds where the borrowed money comes from, and what it actually costs.
Let’s say you want to buy a new computer. You have three choices:
- Save up to pay for it
- Borrow the money
- Steal the money, or the computer
Option 3 is the cheapest, but it has unpleasant practical, moral, and religious side effects.
Option 1 requires you to live within your means, save the difference, and delay owning a PC until you can afford it. You may even buy a cheaper PC so you can own one sooner.
If you don’t like waiting and you don’t like compromise, you’ll probably go for option 2. In some households, option 2 is the standard choice. Such people regularly borrow money to buy everything from the groceries to holidays.
Borrowing might be done via:
- A credit card
- A personal loan
- Adding to the debt in your mortgage
- Using a doorstep lender
- Buying through a hire/purchase arrangement, perhaps with an interest-free teaser
All these options have advantages, costs and consequences. Smarter borrowers shop around for the cheapest method. Others take the first loan that comes along. Finding the cheapest way to borrow is a subject for another article.
The key point for now is that all these methods have the same common structure:
- You borrow money
- You must repay it
Notice it’s all about ‘You’. The agreement may be with American Express or Barclays Bank or whoever, but it’s you who has to repay it. After the advertisements have been forgotten and the repayment is just another line in your monthly statements (and the PC won’t run Sim City 7000 or whatever we’re up to by then) i), you’ll still be liable for your debts.
And where will you get this money? From your future self.
A study in borrowing from myself
I first realized the concept of borrowing from my future self when I was a student. My family was by no means rich, but my dad earned too much for us to qualify for the full student grants for university that were available then to pay for higher education costs in the UK.
As a result, I had to make up the difference by taking out a student loan.
This government loan was a great deal, with a very low interest rate. Better still, I didn’t have to start paying back until my income surpassed a certain threshold. I actually managed to save some of the loan for a while due to the perks of writing for the college magazine keeping my extra-curricular costs down.
Fast-forward a couple of years, by which time I’d left college and was into my first job. After just a few months, I got a pay rise. That was the good news. The bad news was the increased pay triggered the level at which my student loan had to start being repaid.
I can’t remember the exact figures, but basically I was worse off after the pay rise because I’d only just gone over the payment threshold! It was not the most motivating payslip I’ve ever received.
My student self had made my working self poorer by borrowing money.
Of course, my student loan had been spent buying an education that made me more employable. Overall, my future self got a good deal. But this isn’t the case when you’re buying material goods or paying for transitory services using debt.
Borrowing from a poorer, future you
How much money are you taking from your future self when you spend his or her money today?
Unless you use the loan to invest in education, a profitable business or an appreciating asset (such as a house over 25 years), your future self will have less disposable income to spend on things because of your decision to borrow now. Your future self will go without the money you spend today.
Of course, it’s worse than the initial cost. Your purchase today via debt will incur interest. Depending on the interest rate you’re charging your future self – via your credit card or bank loan – you could spend anything from 25% to 100% more by buying the item today, instead of waiting until you can afford it.
In fact, debt is even worse than that! Imagine that instead of going into debt, you lived within your means, saved up for the things you really needed to buy, and invested the excess instead.
Now your future self isn’t just poorer due to the cost of your debt-fueled purchase and the interest on the debt – he or she has also lost the cash you’d have amassed thanks to compound interest building up your savings.
See my article on why you should stay out of debt for cash illustrations of these costs.
This isn’t some abstract person we’re talking about. If you go into debt now, the living, breathing you of tomorrow will look at their bank statements or face unexpected urgent costs, and have less money to spend. One day you’ll retire with less money, if you borrow to buy depreciating assets today.
You’re really sticking it to your future self by borrowing. You’ll be poorer, less able to live within your means, further from financial freedom – and probably lumbered with an old PC that needs to be replaced.
Save now, spend later
Some readers will find this post trivially obvious. If that’s you, I’m very glad to have you reading my site – please do stay in touch for my other personal finance and investing articles. (Here’s one on potentially profiting from mortgage debt).
I know from experience that other readers though will find it a revelation when they grasp their debts are funded by themselves and nobody else. That’s not surprising: The entire financial service industry tries to confuse us into thinking money is cheap and to distract attention from who really pays. The 2007-2008 credit crunch is testament to that.
If the concept of borrowing from your future self is new to you, I hope it’s an empowering idea. Once you grasp that you’re only making your future self poorer by going into debt now, then good consequences follow: you’ll live within your means to avoid debt, you’ll start to see your savings grow, and you’ll have compound interest building up your wealth rather than making you poorer through interest increasing your loans.
If you’re 99-years old and still saving, it may be time to start spending. There comes a time when your future self has to give something back. We don’t last forever.
But in your twenties, thirties, forties and even fifties, you owe it to your future self not to leave him owing you.
Filed under: 5 top monevation, Monevation
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