One of the hardest things for many people to see in relation to their finances is how their actions today are robbing them of future wealth. It’s easy to focus on today and think that if you can make the payments on that living room set that it’s okay. It’s easy to think that borrowing from your home equity to fund a kitchen remodel is a great idea. These are all things you want today and the future seems so far away. You figure there will be time to make up the difference, or that just this one little payment won’t hurt your future. The thing is, every time you borrow money you are robbing yourself of future wealth. You’re committing future dollars to pay for today’s purchases.
Sometimes you have to borrow money in order to increase your future wealth, but these cases are rare and are almost always related to two things: Homes and education. You may have to borrow money to buy a home, but that is an asset that may increase in value and add to your bottom line after many years of ownership. You may also take out money to fund an education. Ideally you’ll earn more money thanks to this education and borrowing that money will have been a good idea. Beyond these two uses, borrowing money is simply robing you of some of your future wealth.
When you make payments on a credit card, car loan, or other type of loan, those payments are sucking money away that you could be saving for later. The higher the interest rate, the worse the impact on your future wealth. Not only are you paying for the items you bought, you’re paying extra in the form of interest. That $10,000 car can end up costing thousands more depending on the length of your loan and the interest rate. All of that extra money is money that has been “stolen” from your future.
It gets worse when you take a loan out against your home equity or your retirement. In these cases, not only are you out the loan plus interest, you’ve lost some of your future wealth building blocks. The money in your retirement plan will continue to grow if you don’t touch it. Even if you don’t add to it, keeping the principal at a set amount will earn you a certain return in the form of interest or market appreciation. When you take out a loan and lower the principal, your amount of return decreases. That money is gone forever. Even if/when you return the account to its previous level, the time when your principal was lower has resulted in a loss that can never be recovered. All of that return that you could have earned in the year or two it took you to pay it back is gone forever.
Home equity loans are another big future stealer. In a normal market, many homes appreciate in value over a long period of time. Ideally, by the time you’ve owned your home for twenty years you’ve paid down the mortgage to a level that is substantially lower than what the house is worth. This difference between what you owe and the value of the house is your equity. Say your house is worth $150,000 and you owe $75,000. You have $75,000 in equity. If the house is paid in full, you have $150,000 in equity. When you sell your home, that is money you get to keep (or put towards another home). When you borrow against your equity, however, you’re stealing that money from your future. If you have $75,000 in equity, but a $40,000 equity loan, your actual equity is reduced to $35,000. This means that if you sell your home, your profit will be considerably less. Should your home decrease in value while you still have that loan, you may lose all of your equity and end up upside down on the home. All of that wealth you thought you had is suddenly gone.
Sure, there are emergencies where some sort of financing or borrowing may be the best alternative. In these cases, robbing your future to pay for today may be the only choice that stands between you and financial disaster. In these cases, you do what you have to do to get by. The problems arise when you make it a habit to borrow money to pay for today’s purchases with tomorrow’s money. When you commit to using future dollars (or money that you will need in the future such as retirement funds or equity) to pay for today’s purchases, you slash your future wealth. Before you sign on the dotted line, think about the impact your choices will have on your future.
Two points.
1) Without knowing all the facts, you can’t always say which debts will increase future wealth. For example, my kitchen remodel might increase my future wealth (haven’t done the math since I don’t intend to take out a loan for it) because finally having a dishwasher will make it so much more fun to cook my own food at home.
2) I think the reason a home can be a good thing to go into debt for is not because it will (probably) go up in value but because it will eventually get paid off. Paying only taxes, insurance, and maintenance will (probably) be cheaper than paying rent.
It’s important to keep your financial future in mind. I know a few older people who don’t really have the luxury to retire (even though they’re at retirement age) because of the mistakes they made when they were younger. I’m definitely looking to learn from their mistakes.
At the same time, you want to enjoy the present and not always be worrying about the future. Though that enjoyment doesn’t need to cost (much) money.
But yes people spend their money on stupid things like expensive cars, which only add the slightest improvement to their quality of life. There are much more fulfilling things to spend that kind of money on…or you could just save that money for a rainy day or for your kid’s education so they don’t have to start their life in the same cycle of perpetual debt that burdens you and eats up most if not all of your paycheck.