Making Borrowing Decisions
When to Borrow
Borrowing can be costly, but it is not always a bad thing.
Sometimes, you must borrow because you need money to fund your purchase. For example, if you want to buy a house, you may need to borrow money from a bank.
Other times, you can choose between your own money and other people's money. For example, if you want to buy a new car, you could save up for it and pay cash or take out a loan and finance the purchase.
The decision of whether or not to borrow depends on the specific situation. If borrowing makes you better off financially, it may be the right decision. However, if borrowing will only make you worse off, then it is best to avoid it.
Reason 1
Using your own money is not free.
Try It Out
Let's say you want to buy a new laptop for $1,000. You face two options:
Option 1
Use your own money from a savings account with a 5% annual percentage rate (APR).
What is the cost of this option?
If you use your own money, you cannot earn interest anymore. The cost of using your own money is the foregone interest = $1,000 × 5% = $50
Option 2
Obtain a personal loan with a 4% APR.
What is the cost of this option?
If you borrow money, you have to pay it back with interest = $1,000 x 4% = $40
Which option should you choose?
Option 1: Use your own money
Unfortunately, this option costs you more money.
Option 2, borrowing money is less costly in the long run. Borrowing money is cheaper because you would save $10 annually. However, it is important to note that this is just an example, and the actual cost of borrowing money will vary depending on the specific situation.
Option 2: Use a personal loan
Nice choice. This option saves you money in the long run.
Option 2, borrowing money, is cheaper because you would save $10 annually. However, it is important to note that this is just an example, and the actual cost of borrowing money will vary depending on the specific situation.
Reason 2
Because you can have the asset sooner rather than later.
Example 1: Taking Out a Mortgage to Purchase a Home
You can borrow money to purchase a home in your early 30s rather than save enough to purchase a home in your later 60s.
Example 2: Taking Out Student Loans to Attend College
Education is a valuable investment that can increase your potential earnings. If you do not attend college, you will likely start working immediately. However, the opportunity cost of going to college is the foregone earnings that you would have made if you had started working instead. Therefore, starting college as soon as possible is important when the opportunity cost is lowest. This will give you the most time to benefit from the increased income you will earn after graduation.