Monday, 09 July 2018
By Tom Hartmann, sorted.org.nz
This doesn’t get said enough about taking on debt – it’s really just spending our future earnings before they arrive.
Perhaps it’s because our future selves are strangers to us. We generally find it difficult to picture them, to see them earning and having to make repayments on what we buy today. If saving feels like giving money away to someone we don’t know, why would taking on debt be any different? “Someone else” (read: future you) will pay for it.
What we’re really doing when we borrow is spending “futuredollars” – money that we’ll earn in the years to come. We take yet-to-be cash flow and use it ahead of time.
This may or may not be what’s best for us – no judgement here – but it helps to think of it as spending our own futuredollars to make sure.
Is it worth it?
Some things will make more sense to borrow for than others. Student borrowing, which is meant to create better options for future income, is an obvious candidate. And since practically none of us walk around with hundreds of thousands in our back pockets for a house, it makes sense to find a home as soon as possible and borrow to live in it. These can be good uses of futuredollars now.
Other things not so much. Many of the things that wind up lingering on our credit cards (holidays, groceries, petrol) would be better paid with cash we hold now.
Why overcommit our future selves when there may be much more pressing uses for money down the line?
Here come the costs
All this talk about spending futuredollars is even before we consider all the costs that come with borrowing. These just end up increasing debt’s drag, slowing down our future selves even further.
Interest tops the list, whether it’s at the low end, like mortgages (hovering around 5%), or up higher with credit cards (typically close to 20%). We then go into nosebleed territory with some peer-to-peer loans (30%) and end – hopefully – with the robber barons of the lending landscape: the payday people (some of whose loans charge north of 500% when annualised).
But what doesn’t always get factored in are the myriad fees that come with borrowing too: establishment fees, annual fees... A high-end credit card, for example, can cost $1,200 a year just to use! (The perks better be worth it.)
Whether interest or fees, someone down the line (future you) will need to pay these costs. Sorted’s debt calculator can help you factor them in and calculate how much weight you’re piling on your future self to carry.
Miss a repayment, all hell breaks loose
What happens if our future selves can’t handle the repayments and the costs? We tend to be optimists, but circumstances change, so it helps to have a plan in place. Mortgage insurance, for example, is fit for this purpose.
On the riskier side of the borrowing spectrum, I am simply gobsmacked by what happens when payments get missed. Defaulting on a payday or car loan, for example, can mean all sorts of added costs get whacked on: default fees, call fees, letter fees, default interest rates.
The load on the borrower’s future only increases, and the loan amount owed can end up ballooning instead of ever coming down. It’s what I call the “tick, tick, boom” effect – when putting things on tick can end up exploding on you.
Which is something I’d never wish on anyone… whether it’s our present or future selves.