What is borrowing?
What is borrowing?
Borrowing is the temporary acquisition of money with the intent to repay the amount borrowed. In a financial sense, if you borrow money, you assume a debt to the lender. The most common form of borrowing happens between a consumer and a lending party usually a financial institution, either via a loan or via another form of credit, such as a credit card.
A loan is a contract between two parties where one party borrows money from the other on the premise that they will pay it back. The principal is the initial amount borrowed from the lending party. The lending party will charge interest, usually a percentage of the principal, in addition to the initial amount over the course of the loan. Interest is the cost of money.
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The lending party will assess your ability to repay the loan, either by checking your earning capacity or by enlisting a guarantor, a person to guarantee that someone will pay back the loan. If the borrower defaults on the repayment, the guarantor assumes the debt. Your ability to repay the loan will affect how much you can borrow.
A credit rating is a record kept by lending institutions showing a history of your borrowing and repayment habits. Lending institutions use your credit rating to judge whether you are likely to meet repayments in the future.
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After you borrow the money, you repay the loan in arranged installments, regular amounts that cover both the interest and part of the principal. This may take several years or even decades, depending on how much you borrowed, the rate of interest charged and the size of the installments.
The main difference between a loan and a credit card is generally the amount borrowed, the interest charged and the length of the repayment cycle; in general, you borrow more on a loan, credit cards charge more interest and loans take longer to repay than credit cards.
Advantages of borrowing
Borrowing money gives you instant gratification by allowing you to purchase something that would be too expensive to pay for upfront, something that you cannot afford yet, such as a car or a house. If you are taking out a loan to buy a house, for example, it means that you can live in the house as you pay off the loan instead of renting while trying to save for a house. If you borrowed money to start a business, you could use some of the profits from the business to pay off the loan.
Credit cards are also convenient in that you can pay for a number of things using this method, such as bills, online transactions and retail purchases. Although the interest rate on a credit card is usually far higher than that on a loan, if you can manage your money and repay the full amount before the due date, then you need not pay any interest on the money you borrowed.
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Disadvantages of borrowing
There are a number of drawbacks to borrowing money, the first being that because you pay interest on top of the principal, you will eventually pay more for the item than its initial price. As previously mentioned, it can also take a long time to clear the loan debt - several years, or even decades - depending on how much you borrow.
Having access to a lot of money through borrowing can lead to overspending, which in turn could mean that you may find it increasingly difficult to repay the amount. If you cannot clear your debt, then the lending party may exercise their right to repossess (reclaim) the item in order to recover the outstanding money. Inability to repay a loan would also negatively affect your credit rating.
