Why borrowing is so seductive, but so damaging. Is it modern slavery?

The writer and thinker Aldus Huxley (he of ‘Brave New World’ and ‘The Doors of Perception’ fame) said somewhere that the modern world order was based on universal debt, planned obsolescence and constant war. Here we’ll have a look at the first and how it’s keeping many in chains.

Borrowing these days is so seductive, particularly where interest rates have been so low. To be fair the only way to enjoy some ‘big ticket’ items (such as your home) for most people is to borrow and that can’t be helped. But it’s worth bearing in mind a few things:

  • Anything you earn is taxed- maybe at 30% for a basic rate taxpayer (20% tax plus 10% National Insurance), 42% for a higher rate taxpayer (40% tax plus 2% NI), 62% between £100k and £125k a year (40% tax + effectively 20% extra tax from losing your personal allowance + 2% NI) or 47% (45% tax + 2% NI). Whichever way you cut it, it’s a lot.
  • Anything you borrow feels ‘tax free’- when you borrow £20k for a car you have £20k to spend on a car. When you borrow £500k for a house you have £500k to spend on a house. It feels a very easy way to get what you want when you want it.
  • However, you need to repay all this from taxed income- and this is an uphill battle! To repay that £20k for the car you need to earn about £30k before tax, even as a basic rate taxpayer and ignoring interest. To repay that £500k mortgage you need to earn over £850k as a higher rate taxpayer.
  • And then there’s interest of course. If you’re paying interest at 5% and repaying over 30 years then you’ll end up paying almost as much interest as the amount you borrowed. And, again, you need to pay tax on the money you earn to pay that interest!

Suddenly that £500k for the house seems pretty expensive. £850k of earnings before tax to pay off the loan and possibly £850k of earnings to pay the interest= £1.7 million of earnings/a lot of hard work for that £500k initially.

To be fair, at least if you put the borrowed money into an asset like a house it should itself gain value over time. Maybe it will be worth about £1.2 million (growing at 3%pa) but may be more (or less!)

It’s more of an issue if you’re borrowing to spend on something with a falling value, or no lasting value at all- cars and especially holidays and day to day spending are real problems.

While you might not think you’ll have a car loan for 30 years many people get in the expensive habit of upgrading their car with borrowed money for much of their lives, and normally at much higher interest rates.

What if you saved that money instead? What if you saved that money in a pension instead?? I’m glossing over a few things here but what if instead of paying that £500k mortgage at £2,600pm for 30 yrs you had £4,400pm going into your pension (with higher rate income tax relief). What if, instead of paying 5%pa interest you collected 5%pa interest? Crunch the numbers and you’d have about £3.6 million in your pension! (It’s worth noting that you’d probably pay tax as you took this out- assuming 40% this would still be over £2 million in your pocket.) If you got 7%pa growth then the numbers get silly- more like £5.4 million (before tax). Still fancy that £500k mortgage?

What’s more sinister than the numbers is the impact on your freedom. If you don’t have debt you might be rich or poor, but you’re free. You can take a risk with your career or a business, maybe take a break for a while. When you owe then you have to keep working, keep earning, keep paying or you’ll lose your stuff at best, your home at worst- and that’s stressful!

All this is also very ‘middle class’ borrowing, but for millions of people struggling to make ends meet debt is often the only option. For many, punitive interest is the norm and any kind of saving or investment is fanciful. If you tried to repay a £1,000 loan over 40 years at 20% interest (normal for a credit card) you would pay ‘just’ £17pm but a total of £7,000 in interest! If you saved £17pm into an ISA (so no tax) paying 5%pa? You’d have £26,000!!! Still want to spend on a credit card if you can possibly help it?

Of course debt can be necessary and useful, but there’s no excuse for how little people are taught about the true cost of it.

Modern slavery is probably a bit strong, but it isn’t far off.

Action point– Think carefully about the true cost of borrowing, in money and freedom, and whether it’s worth it to you.

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