We all know it costs money to borrow money. You have to pay interest and usually several fees, too. It is my experience that people don’t know what they pay. They have no clue about what they give up. This article presents a different way of looking at the cost of borrowing money.
If you think about it, our lifetime income is equal to our lifetime spending. The income is equal to our spending. Stop and imagine that for a while!
During our lifetime we can never spend more than we earn. What about if we have a net debt when we die, you might think? In my mind that is just a donation to us from our creditors. If we have a positive net equity at our death, it is simply a donation from us to our inheritance.
It might be a bit philosophical, but try to get a grasp of the concept behind it. It might help change your perspective on what debt does to your financial life. If we can agree on the point that our lifetime income equals our lifetime spending, then we can also start to divide our lifetime income into the different things we spend it on. We have the total rent we pay through our life, the total amount we spend on food and the total amount we spend on having fun, just to name a few. But if we have debt, we also have the total amount we spend on interest on the debt.
Now let us try to look at an example to understand this. For simplicity’s sake let’s assume the above expenses are the only ones we have during our lifetime. Let us also assume we have a lifelong income of $300 we can spend and that we leave a net equity of $0 at our death.
If we don’t have any debt, we can spend it all on the rent, food and fun. We might spend an equal amount on each of the three items, which is $100 on each item. However if we do take out debt we also have lifetime expenses on interest. Maybe we have to pay $30 in interest in this example. If we still have to pay $100 for rent and $100 for food, it means we can only spend $70 on fun. That’s not so much fun! So, being impatient to receive the goodies life has to offer us, will actually lead us to enjoy less of these goodies. That is, unless you are actually happy to pay interest.
This is, of course, just an example. Real life is much more complicated, so try to just understand the concept of this. If you start using this information every time you purchase on credit you might end up with more money for fun in your life. Next time you are considering buying a new pair of pants on credit, remember that you might actually pay for two pairs of pants.