Private money loan: Which one is better for you? Paying off Debt or Save Cash?

In the F.I.R.E community and in the other investments communities like Dave Ramsey or Robert Kiyosaki,  financial decisions are often driven by logic. While saving for a significant purchase is traditionally seen as the best choice, many people struggle with the discipline to structurally save and are increasingly turning to private money loans to buy products.  The last years we were asking ourselves often whether paying off debt or save cash first was better. Using private money loans and debt instead of saving and/or mortgages to finance assets seem counterintuitive at first, but there are compelling psychological reasons behind this choice.

Let's explore why we are using private money loans to acquire assets and we that can sometimes be more effective than saving up for a downpayment (even though that concept is barely exists in the Netherlands).

The Immediate Gratification Factor

One of the primary reasons people opt for private money loan or creditcards is the allure of immediate gratification. We, as a society became so impatient that we want instant access to goods and services, that we are not willing to wait to save enough money for a purchase. The only thing we see it that we are able to buy an item we want instead of seriously think about whether we need the item.

The Psychological Commitment to Repayment

Interestingly, the obligation to repay a loan can create a stronger psychological commitment to saving. When you take out a private money loan, you are bound by a contract to make regular payments. This structured repayment plan can instill a sense of discipline that might be harder to achieve when saving voluntarily. The mental pressure of having a debt to repay motivates us to prioritize our finances and avoid unnecessary expenditures.

Assets vs Liabilities

Most of the people don’t actually use debt to acquire assets, but mostly use it to acquire liabilities. The difference between those two is that assets are either putting money periodically in your pocket or appreciate in value over time. Liabilities are items that depreciate over time (or directly) and/or costing money during the period you own (like a car). We mainly use debt for assets (although we have used it for a car in the past also), like buying an apartment. This apartment is earning us every month money therefore it is an asset, but because we try to repay these debts as fast as possible, the assets has a negative cashflow for the first few years.

Building Financial Discipline

In the Netherlands or in Hungary (and most European countries) we don’t have a credit score system, therefore loans or credit can’t be used to boost your score. Loans and credit is basically only costing money.  Additionally, we experienced that the discipline required to manage loan repayments is translated into better overall financial habits, forcing us (during the loan) and encouraging (after the loan) us to budget more effectively and save consistently.

Leveraging Low-Interest Rates

In some cases, private money loans can offer quite good interest rates compared to other type of debt. Our first private money loan in 2019 was our 3,5%, which is in overall lower than the average rent for apartment. Currently the interest rates are around 7% in the Netherlands. With the current rental income compared to the house prices you would not make a lot of money on the asset, making the business case a bit harder to make.

The Forced Savings Mechanism

Repaying a loan can act as a forced savings mechanism, especially with a businesscase that depends largely on a much lower debt ratio. When you commit to monthly loan payments, and preferably extra payments, you are essentially setting aside a portion of your income each month. This can be particularly useful for persons like us who struggle with the discipline of saving in a structured way on their own.. The structured nature of loan repayments ensures that a specific amount of money is allocated towards the asset each month, gradually building equity with an increased “savingsrate” they would otherwise not achieve.

Emotional Satisfaction and Stress Reduction

Finally, the emotional satisfaction of owning an asset sooner rather than later improved our self-confidence enormously. The sense of accomplishment that comes with acquiring an piece of real-estate provided us with a significant motivational boost. Additionally, knowing that we are actively working towards a specific goal created a sense of control.

Conclusion

While saving for a significant asset or financing it in a way that produces a positive cashflow is undoubtedly the most logical and financially sound approach. That approach is much harder attainable for some people, because it requires more real-estate experience (buy low) and more finance knowledge. If you are like us and have a hard time delaying gratification, then maybe our approach could be something to consider, as long as you try not to overreach.

By understanding the psychological factors, you can make a more informed financial decision that aligns with your personal goals and mental well-being.

What do you think about this approach? Do you have any specific assets in mind that you would like to invest in?