Borrowing Money is the Same As Buying Risk

To borrow, or not to borrow…that is the question. Not for me; I don’t borrow money.

It is easy for those of us recovering from a debt binge earlier in life to declare we will never again borrow money. However, life is not without temptation, and sometimes the temptation has less to do with the acquisition of stuff, and more to do with things like cash flow, interest rates, and other more sophisticated finance concepts.

For instance, take the issue of cash flow. Let’s assume I am interested in a new (to me) pickup truck. I find a good deal on a late model used truck for $18,000, and I can finance the truck through my credit union at 2.99%. I find a similar good deal at the dealership on a new truck for $25,000, at zero percent interest, and have plans to make it a million mile pickup truck.

The obvious savings can be realized by choosing the used truck over the new one. Further, I could pay cash that I’ve been saving up and avoid the 2.99% interest, and any other fees associated with financing a car. However, that would leave me $18,000 less in savings. Do I care? Maybe.

Let’s also assume I have about $25,000 in savings. Paying cash for the used truck would drop my cash reserves down to $7,000, well below my comfort level for emergency savings. Paying cash for the new truck would leave me with nothing.

Financing the new truck at zero-percent interest is an attractive option. I’d likely only have to pay a couple thousand dollars the day I purchase the truck (for tax, tag, title, etc.), preserving $23,000 of savings for other emergencies.

Of course, my monthly payments will be higher because I’m financing a larger amount, which cuts into my monthly cash flow. And it is a significant obligation to take on a payment of a few hundred dollars every month for 48, 60, or 72 months.

What’s Missing from the Calculations? Risk

This is where the decision gets easier for me. I would much rather pay cash for something up front and own it, rather than be obligated to make payments for many years into the future. Agreeing to the latter adds significant risk to my life.

What if I lose my job in a year and can no longer make payments? What if I decide I’d like to downsize my lifestyle and take a lower paying job doing something I love? What if I got sick and had to live on long-term disability?

It would be much easier to face those circumstance minus a car loan, but is the reduction of risk worth such a large cash outlay? No. Not for me. Which brings me back to the original dilemma – borrow or pay cash. I say neither, given the scenario I presented.

I’ve been in debt, and never again will I go back. I’ve stayed awake at night wondering how I’d pay all our bills. I have stressed over money. I’ve allowed debt to drive life’s decisions for too much of my life. To put it blunty: being in debt sucks.

A Third Option: Do Nothing

If I was faced with this dilemma I would choose option 3 – wait. Wait to save up cash above and beyond our minimum emergency fund requirement.

If I had a solid emergency fund, and another $18,000 in cash earmarked for a new truck, great, let’s pay cash.

If I wanted the new truck for $25,000? Keep saving until I had enough to pay cash without touching emergency funds.

If I needed a truck right now because my current one is beyond repair? Find a used one for $5,000, pay cash, and move up later.

But I Have No Savings and I Need a New…

The point it we always have options, even when we think we don’t. Often times people buy a new car when their current car dies, and they find themselves in a pinch. Of course they finance that new car because they have not planned for their current car’s demise. All cars die. It’s just a matter of time. Might as well start saving for it now.

This discussion should not be limited to cars. Washing machines break. Televisions die. Computers fry. Sofas and recliners eventually get uncomfortable and need replacing. Start thinking about the demise of the things you own today, and plan for their replacement so you won’t be surprised tomorrow.

I suggest saving in sinking funds and targeted savings accounts for these types of events. We maintain savings accounts dedicated to things like home repairs, auto repairs, a new recliner (ours is pretty worn out), a new computer, etc.

When something breaks and needs repair or replacement we don’t have to talk to a loan officer to finance the crisis, we simply write a check from our emergency savings and move on. Even if you can only afford to put back $20 from your next paycheck towards the next emergency, do it.

That $20 every paycheck will soon grow to a $200 reserve – enough to cover a minor auto repair, or replacement part for your refrigerator when it quits cooling. You’ll be so glad you saved money all those weeks, and can finally begin to free yourself from the chains of debt.

Comments

  1. Borrowing risk is a scary thing, one that is taken much to lightly. I like the trading up method for getting a new car. Like frugal dad said instead of buying the $20,000 truck buy a $5,000 one cash and after driving it and saving longer if you need that other truck later on sell it and buy a new one. Yes the truck you bought for $5,000 will depreciate and won’t be worth that when you want to sell and upgrade. However the saved money on interest alone will save you a lot of money. A truck costing $20,000 with a five year loan at 2.99% interest will make you pay $50 a month in interest. Over the 5 years you will pay over $1,500 dollars in interest. What could you have done with that money instead?

  2. I love shiny, fast cars. I used to have a BMW that would truly give me a rush every time I drove it. I’d get out of the car and think, “wow, that was fun.” Now I drive a truck. I don’t think I’ve ever gotten out of it and felt the same. I am able to get where I need to go and carry kids and kid’s cr…stuff. Oh, the lust of a fine automobile still lingers though and the desire to buy another often grabs hold. It’s in those trying moments that my disgust with debt causes me to do what every red-blooded man with a wife and kids should do — pout and be a bear for 2 or 3 days until I realize again that life’s not about fancy cars. Then about four weeks later, the cycle repeats itself. But, hey, the truck’s running great!

  3. I’m almost too risk averse, so I’ll always go the cash route if I have the means to do so. I’ve actually paid off 0% student loans ahead of time because I just didn’t want that fixed expense over my head in case something happened down the line.

    As your family grows, it seems like the list of stuff that breaks and needs replacing is never ending. The sinking fund is crucial in my opinion.

  4. I am very much against debt. I paid off my mortgage before putting a penny into investments. And I generally agree with you on the risk point: Debt limits your options and that adds risk to your life. So in general we are on the same page, Jason.

    One caveat I would add, though, is that there are also circumstances in which taking on debt can reduce risk. Say that you are stuck in a dead-end job and a friend wants to hire you to work at a start-up but to do it you would need to borrow because it is going to pay little in the early years. You might be missing out on the opportunity of a lifetime by being unwilling to take on that debt.

    I think you need to look at the nature of the debt being taken on. I would never take on debt to pay for a vacation or to buy a bigger house than I need or a bigger car than I need. But I would take on debt to go to school or to start a business or to buy a house that I need to live in to make accepting a good job a realistic option. Debt used for consumption is always bad. Debt used for growth can be justified in some circumstances.

    My understanding is that in the days when there were laws against usery (charging interest on debt), charging interest on a debt used to start a business that would generate a profit was permitted. The thing that was considered immoral was charging interest on debt that would not itself generate the means to pay off the debt at some point. Unfortunately, most of today’s consumer debt falls into that category.

    Rob

  5. I would pay cash all the way, even though it may not be the ‘wisest’ financial decision. (Assuming I can make more than 3.5 percent or so on my investments instead of plunking all my cash on the vehicle.) However, I can’t stand low cash reserves, and buying a new car is not always the best choice.

    So much to consider!!

  6. one other option – Pay Cash for the used truck, then take out a small loan for the amount that you want your savings back up to…say a $8000 loan against the truck, on the lowest monthly payback possible, with no prepayment penalty.
    Then make payments against that small loan like you would on the new truck – say $700 month – way above the minimum required. Within one year you will have the truck loan paid off. The good part is that at almost no time will you owe more than you still have in savings, in case of emergency :)

    While there is a small risk, you have it covered at all times, plus the minimum payment should be small enough that hopefully you could still cover it if things went bad.

    • PS – this is what I have done in the past on my houses – as a single woman with an income that tends to shrink in our area in the winter due to bad weather etc.
      I always made the minimum payment be what I could afford on unemployment, if that happened, which it never did…. then made huge payments when I could (most of the time). It meant paying off a 30 yr loan in under 10 years, and with little stress, knowing I had the minimum payment covered even if I were on unemployment. (house prior to this one – this one I paid cash for)

  7. I would say that, if the new object is not VITAL, one should avoid debt at all costs. Especially now, when people lose jobs so easily and get back on their feet harder and harder. If you have money to pay for it NOW, you might consider this, if the object is indeed something you really need. If not, better keep the money for some really serious problems.

  8. I like the comments that state debt is overall a bad deal. When we talk about good debt verse bad debt, good debt is a oxymoron. It’s DEBT=RISK. People see the benefit of debt and don’t see the risk. Most peoples risk detectors are broken or never installed. I talk to people about how to do things without debt and they look at me like its impossible. They are taught in our culture debt is normal and good.

  9. Not be a lender, nor a borrower (or something like that). People often say money isn’t important but it seems to be one of main reasons of many arguments and stresses. A while ago, I saw a picture of a girl sleeping. Instead of counting sheep, she was counting her bills: gas bill, car payment, home payment, student payment, insurance payment, grocery bill, etc… I feel so connected to that picture. Debt is bondage. As long as you have debts, you don’t have to freedom to do what you want because you fear that you won’t be able to make the payment if you lose your job. It would be great if you can contribute small saving every month toward major events but not everyone is able to do that. You do what you can and take good care of what you have.

  10. Many personal and business financial crises are caused by a mismatch between the asset (your paycheck) and the liability (your car loan or home mortgage for example). Since few outside the very wealthy and labor unions have guaranteed income, it is a mistake to borrow from the uncertain financial future to pay for things that rust today. In my blog post I discuss how your financial legacy is determined by the money decisions you make today.
    http://wp.me/pZTwu-1F

  11. Buying risk is a god way to look at borrowing. As you said, it is much easier to face a financial crisis with no debt! You will only need to adjust your living expenses – which are much more flexible than debt payments!

  12. This is exactly why my husband and I have never had cell phone plans. What if we needed to cut back on expenses suddenly and got socked with a hefty cancellation fee?

    We bought inexpensive prepaid phones years ago and we pay as we go. The risk of having to pay that huge fee isn’t looming overhead and we sleep better at night knowing so.

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