Taking out a loan can seem like a good idea when your savings are low but your income is large and steady. Why not go ahead and get that new car or bigger house? Or maybe you’d like some extra cash to apply to your investments? Taking out a loan can give you financial freedom now with the expectation that you’ll be able to pay for it later. The assumption that you will be able to repay the loan is the reason that borrowing money is often problematic and rarely a good idea in non-emergencies.
The major downside to borrowing money, of course, is paying interest. The cost of interest on a home mortgage, for example, is almost always more than the home itself. Purchasing an item on a credit card and paying for it slowly can often double or triple the cost of that item.
You may be able to afford the loan payments now, but no source of income is guaranteed. The job you love today might be the one you hate tomorrow when the company gets taken over by new management. Do you really want to be tied to a job that makes you unhappy simply because you have too many financial obligations?
Even if you feel you will always love your work, no one can say whether or not you will still be employed a year from now. With layoffs still on the rise, even talented employees are losing their jobs. No one is safe; those with too much experience and education are cut because their salaries are too high. Those with too few skills or not enough experience are laid off because they don’t contribute enough to the bottom line. Realistically, all workers today should be emotionally and financially prepared to make a sudden job change.
The more debt you have, the harder it will be to adjust to a pay cut or layoff. If you lose your job or your investment plans don’t work out as expected, you will still need to repay your debts. The more you are paying in interest, the less you will have for your basic needs, let alone extras like entertainment.
Even if you manage to keep making a good income, the interest you pay on a loan decreases your overall financial wellbeing. Instead of paying that interest, you could have invested the money in a savings account or used it to pay off other debt and hence save money. Hence, in addition to the actual cost of the interest, there is an “opportunity cost” of what you could have saved or made had you not taken out the loan.