Advantages & Disadvantages of Borrowing Money From the Bank

Almost everyone will borrow money from a bank at one time or another during their lives. When you borrow money from a bank, the bank charges interest on the sum you borrow, which is a cost you must pay in addition to paying back the original amount you borrowed. Borrowing money from a bank can have several advantages and disadvantages.

Large Purchases

Borrowing money from a bank can enable you to make large purchases that you might not be able to afford otherwise. Homes, cars and education are just a few of the things that bank loans can help you purchase. Without willing lenders like banks, it would be far more difficult for people to own homes, start businesses and make many other common purchases. Bank loans help facilitate economic activity.

Credit Implications

Borrowing money from a bank can have both negative and positive impacts on credit scores. The total amount of debt you have and the amount of new debt you take out will tend to reduce your credit score. In the short term, taking out a new loan from a bank will typically hurt your credit score. On the other hand, making payments on time and having a long credit history can boost credit scores. If you are able to pay off your loan successfully, it may increase your credit score.

Building Wealth

Borrowing money can be detrimental to building wealth over time. When you borrow form a bank, you must pay interest on the money you borrow. The interest you pay decreases the amount of money you will have leftover to save or invest. Interest payments can be large for expensive purchases such as homes and cars. For instance, if you get a 5 percent interest mortgage on a $100,000 home, you will pay thousands of dollars in interest a year.

Good Debt vs. Bad Debt

Certain types of debts are often considered "good" while others are considered "bad." Borrowed money spent toward something that has the potential to provide income or an increase in value, such as education or a home, is considered "good debt." Borrowed money spent toward depreciating assets and things that do not provide income or an increase in value, such as cars, clothes and living expenses, is considered "bad debt." Good debt can potentially lead to higher income or a positive return on investment.