Blogs | January 5, 2012

Is it stupid to take a loan for a holiday?

Vanessa asks: I borrowed about €5,000 for a vacation. My friend says I am stupid to do it because I will still be paying off debt after the trip but she is borrowing about the same amount for a car. Who is right?

Ian answers: Far be it from me to come between friends and their finances – it can lead to something like the fireworks that can spark off when couples debate about money, about who’s spending what and where financial priorities should be. Volunteer your opinion in that (very important) conversation and you could end up burnt. But seeing as you have invited me to pass comment on the spending choices you and your friend are making, let’s take a closer look.

In my view, three issues are raised here: attitudes to borrowing in general, what we should borrow for and the implications if you and your friend are more than “just friends”.

To borrow or to save?
Both you and your friend have decided to take a loan rather than save to get what you want. There’s nothing necessarily wrong with that, provided you’ve done the sums and are confident you can repay the debt. In your full question, you write that you and your friend have similar incomes, so let’s assume you are both comfortable with the amount of debt and can repay it. I am left puzzled about the attitudes to debt being displayed.

Perhaps the holiday is a once in a lifetime opportunity and the car is a great bargain. Maybe. But why not save for each? Planning and saving in advance can actually increase the pleasure once you reach the goal, according to research cited by Psyblog. It’s a form of delayed gratification. Savers can revel in the anticipation of their upcoming trip or their first drive in a new car, perhaps celebrating each time they reach a step towards the savings goal.

Further, it’s possible that your bill is more likely to creep up if you finance by debt rather than saving and paying by cash. Not only from interest on loans but because the so-called endowment effect means we can tend to emotionally commit to owning something before we actually own it. As a result, we might be tempted to pay more or to buy a more highly specified version when buying with credit. As explained in an earlier Ask Ian blogpost, this can definitely affect decisions when buying a car. The endowment effect is usually expressed as people placing a higher price on things they own than their actual worth – with property a common example. The interaction of ready access to credit with its ability to own things more quickly and the endowment effect can lead to people taking out larger loans than financially prudent.

While we are on the topic of thinking traps, let’s take a moment to consider if that holiday is really a “once in a lifetime opportunity” or if peer pressure is in play?

Are cars different from holidays?
If we step aside from the potential thinking traps that you and your friend may be falling into, the plain vanilla economist in me notes your friend may have a point. The car and the holiday are likely to be different types of expenditure. The holiday is probably consumption and the car investment. In all likelihood, once the holiday is taken there will be little left at the end to show for it.

You can’t get a refund. Meanwhile the car could give your friend several years of enjoyment and may have other benefits, including freedom to travel. If the car does not live up to expectations, it can probably be sold and your friend can join you on public transport or bicycle.

In general, if something can be used over a period of time, it can make sense to spread the cost by taking out a loan.

More than “just friends”
But now I will speculate further. If you and your friend are in a long-term relationship, it is possible that the decisions by one to purchase a car and the other to go on holiday are not separate. How couples decide to divide their spending and saving can vary greatly.

However, if one is “a spender” and the other “a saver”, there may be some stress setting financial goals, such as saving to put a deposit on a house. As I’ve said above, these (very important) discussions can lead to fireworks.

But if it is the case that this friendship is long lasting, perhaps it could pay for you and your friend to discuss whether you can really afford both the car and the holiday. Or either of them.

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Ian Bright
Ian Bright

Senior economist at ING
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