To save up or borrow? This question is essential when talking about how your net worth will develop the coming years.
We both believe in saving up to buy the things we want rather than borrowing. And why so? Our main reason is the total cost. Things get way more expensive when you choose to borrow the money AND your future disposable income will be lower (not forever – we know). This starts an evil circle towards borrowing more money, because it then takes even longer to save up again. Therefore we find it more attractive to save up for the things we want in advance, even though we sometimes have to wait longer to get it.
A short example:
You borrow 50.000 DKK and pay them back over 5 years with yearly repayments to an interest rate of 8% per year. After 5 years you will have payed 62.614 DKK in total:
- Repayments: 50.000 DKK
- Interest: 12.614 DKK
The product you bought just got about 25% more expensive!!
This shows how much money you can save in the future by saving up instead of borrowing the money. And this example didn’t even use a super hight interest rate. You can find lots of providers offering quick loans to extremely high interest rates, so be aware.
All this being said, we have a few exceptions to our “always save before you spend” attitude. Where we would never borrow money for furniture, vacations, electronics and so on, borrowing money for bigger issues like cars and apartments can be necessary. As we have both car and apartment, we have been through the discussion on whether to save up or borrow for both issues:
One year ago we bought our first car. We had multiple considerations on whether we should buy a used car or a new and in what price range it should cost. We ended up buying a new car for approx. 170.000 DKK (27.600 USD) as it suited our needs and was cheap in insurance, petrol, and other yearly costs. Then the next question arose. Should we use our savings (yes we had already saved this amount) or should we borrow the money? Our reason for considering borrowing when we already had the money was if we could borrow cheaper than what we expected to earn if we invested the 170.000 DKK. Even though some of the loans seemed very cheap in regard to the interest rate, we found them to be too expensive when adding the cost of establishing the loan. Taken the cost of the loan and the psychological fact that we should be paying a fixed amount for the car the next 5-10 years, we chose to pay the entire amount up front. We know this is not an option for everyone, but we had saved up money for some time and decided not to buy a car more expensive than what we could pay cash.
Where you can discuss if you want to borrow or save up for a car, the story is for the most people a bit different when it comes to real estate. Usually it requires a lot more than what is possible to save up within a reasonable timeframe, which is why we see the point in borrowing money for this. Do we then owe money for a loan in our apartment? The answer is yes, which lead us to the next consideration we recently had. As we don’t owe more than what we could save up together over the next two years (IF we didn’t invest a dime in the meantime!) we have discussed wether we should save up and pay out the loan or if we should continue investing the money. The interest rate on our loan is not very high, so for now we have decided to keep investing the money, as we think we can earn a higher return by investing the money than what it would save us in monthly cost for the loan – at least on the longer term.
As you can hear, our attitude towards borrowing money is fairly conservative, but not resistant. We try to keep our debt low so we can save for the future. Right now we are so-called DINCs (Double Income No Children) which makes it possible to keep up a high savings rate. That could however easily change in the coming years so it is probably not a bad idea to save a bit up for that. How do you feel about debt?