What I Wish I Learned About Money Management 10 of 12: The Cost of Borrowing
We live in a world where credit offers are everywhere. Credit cards, personal loans, student loans, car payments and “buy now, pay later” offers are all designed to let you enjoy something now and worry about the cost later. But “later” comes faster than you’d expect, and when it does, it can hit like a financial freight train.
Let’s take a look at the hidden cost of borrowing and how to do so responsibly.
Interest: the cost of borrowing
When you borrow money, whether through a credit card or a loan, you’re not just agreeing to repay the amount you borrowed; you’re agreeing to pay interest on top of it. This interest is the lender’s fee for letting you use their money. And depending on the interest rate, that fee can be steep.
For example, let’s say you put a $1,000 expense on a credit card that has an 18% annual interest rate and you make only the minimum payment each month. It could take over five years to pay off, and you might end up paying $500 or more in interest. Ultimately, you may be paying $1,500 for something that originally cost $1,000, just because you didn’t have the cash upfront.
It adds up quickly
Borrowing is particularly dangerous because it can quickly turn into a habit, especially when you don’t actively see the total amount tally up with every purchase. Once you get used to paying for today’s stuff sometime in the future, it can easily turn into your first option when facing a new purchase. Before you know it, you may be juggling multiple payments, high interest rates and a growing sense of anxiety every time a bill arrives.
Borrowing isn’t always bad — but it has to be done responsibly
It’s important to note that borrowing money isn’t inherently bad. When used wisely, debt can be a powerful tool and ultimately improve your financial health. For example, a mortgage can help you purchase a home, which is an asset that will generally increase in value with time. A student loan might open the door to better career opportunities. The key is to borrow intentionally and to understand what you’re really signing up for. That means reading the fine print, asking about the APR (annual percentage rate) and doing the math. If you borrow $10,000 at 6% interest over five years, you’ll end up repaying around $11,600 when you include approximately $1,600 in interest on top of the amount you borrowed.
When borrowing with collateral, it’s also important to consider how the value of the item you’re borrowing against will change over time. For example, a house will generally go up in value, but a car will, in nearly all cases, lose value with time.
What to know before you borrow
It’s important to keep these points in mind when borrowing:
Minimum payments are traps. Just paying the minimum on a credit card is a way for lenders to collect more interest. Always aim to pay more than the minimum amount due, and ideally, pay it in full.
Your credit score affects your interest rate. A good credit score can mean the difference between, for example, a 5% and a 15% interest rate. Over time, that can mean thousands of dollars in savings.
Borrowing for wants is rarely worth it. Taking on debt for something you don’t really need — like a vacation, expensive clothes or the latest tech — usually leads to regret. If you can’t afford it now, save up for it instead.
There’s emotional weight to debt. It’s not just about numbers. Debt can create stress, limit your choices and affect your mental wellbeing. Living within your means, on the other hand, can bring you real peace of mind.
An emergency fund is your best defense. Many people borrow because they don’t have cash on hand when life throws them a curveball. Building even a small emergency fund can keep you from reaching for that credit card when the unexpected happens.
Borrow sparingly, and when you must, be sure to learn the costs upfront and to do it wisely.