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The really obvious thing we all forget when borrowing money

[1]Have you ever wondered who you’re borrowing money from when you go into debt [2]?

If you think you’re being given money by a bank or credit card company, think again.

In this piece I’ll 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 through which you can borrow money. They don’t give you a penny 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:

  1. Save up to pay for it
  2. Borrow the money
  3. Steal the money, or the computer

Option 3 is the cheapest, but it has practical, moral, and spiritual consequences.

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 their summer holidays.

Borrowing might be done via:

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 is that all these methods have the same common structure:

  1. You borrow money
  2. 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 no longer runs Sim City 7000 or whatever we’re up to by then), you’ll still be liable for your debts.

And where will you get this money from?

From your future self.

A study in borrowing from myself

I first realized the concept of borrowing from my future self when I was quite young. My family was by no means rich, but my dad [3] earned too much for us to qualify for the full student grants that were available back then to pay for higher education costs.

As a result, I had to take out a student loan.

The government loan was a great deal, with a very low interest rate. Better still, I didn’t have to start paying it back until my income surpassed a certain threshold.

I even managed to save some of the loan. Writing for the college magazine kept my extra-curricular costs down, as we got free tickets to all sorts of things across London. And being young [4], I had little need to spend money.

Fast-forward a couple of years, and I’m into my first job. After a few months, I got a pay rise.

That was the good news. The bad news was I’d hit the level where my student loan began to be repaid. I can’t remember the exact figures, but the gist was 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, university back then was a no-brainer (unlike today [5]) and my student loan had been spent buying an education that made me more employable for years to come. My future self got a good deal.

But this isn’t the case when you’re buying stuff or paying for services or holidays using debt. All the benefit arrives in the short-term – but you pay for it over the long-term.

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 [6] 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.

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, and invested the excess instead.

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 [7] building up your savings.

See my article on why you should stay out of debt [8] 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 [9] 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 junking.

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 subscribe [10] to get all our personal finance and investing articles.

I know from experience that other readers will find it a revelation that 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 us from who really pays. The 2007-2008 credit crunch [11] 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, good things will follow.

You’ll live within your means [12] to avoid debt, see your savings grow, and compound interest will build your wealth [13] rather than making you poorer through interest increasing your loans.

Of course if you are 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 [3].

But in your twenties, thirties, forties and even fifties, you owe it to your future self not to leave them owing you.