Investment Loan vs Consumer Loan | What’s the difference?

Two good friends from childhood – Jack and Paul – met after years in the bar. They began to talk about their life and when it came to finances, it turned out that Paul has a full-time job and lives from pay-check to pay-check and Jack earns good money from his own business. Paul needed money and he decided to ask Jack for help.

The first situation – Paul said to Jack – “Listen, pal, I have a great business idea. I work in a motorcycle shop and I noticed that parts are very expensive. Many of them I could produce and sell a lot cheaper if I had the right machine. The product, at the same time, would not lose quality. Unfortunately, I cannot afford such a machine, because I do not have any savings, but I calculated that my business would yield me about $1000 more than a full-time job. Please lend me $3000 so I can buy this equipment. ”
Jack said – “Paul, I don’t know, because even though your business looks promising, something could go wrong and then I would lose my $3000.” Paul proposed a different solution – “Okay, let’s agree that if the business succeeds, I will give you about 10% more than I borrowed from you, it will be your reward for your risk.”

Should Jack grant such an investment loan? Of course, Jack must first know Paul’s business plan, because the decision is only up to him. He is a man who has capital, because he has made savings. If he assesses that Paul’s plan is good, then the loan should be granted and the capital will bring benefits to both of them. If he finds out that the plan is bad, because Paul would like, for example, to make the parts of wood instead of metal, he should refuse, because his capital would be wasted. Should we blame Jack, that he wants to get some interest from the loan? No, because it is payment for at least two things. Firstly, the risk of losing money, which, after all, Jacek did not get from anyone for free, but earned it with his hard work. Secondly, for the creation of new opportunities for Paul which otherwise he would never have had. Jack would benefit from the loan only when Paul would benefit from it. If Paul fails, he will just not have a possibility to repay it. The investment loan is a very important factor in economic development, as it allows people to establish a business much faster than they would if they would have to accumulate capital for many years.

Now the second situation – Paul said to Jack: “Listen pal, if you are so successful in life, lend me please $3000 because my wife wants us to go to Italy for vacation, I will pay you back with interests!”
Jack thought for a moment and said: “Then why won’t you use your savings?”
“I have no savings, I have so many expenses. Tickets to cinema, a dinner out, or a new television. I cannot save anything”- answered Paul.
“Then how do you plan to pay me back the money with interest, if you have not set aside any money for so many years?” – asked Jack.
“Look, it’s not gonna be a problem, after return I will be relaxed and tanned. There will be peace and quiet at home as my wife will be satisfied. I will then be able to take overtime and repay you.”
Should Jack agree to such a consumer loan? Of course not. He should not agree for both his and Paul sake. If over the years, Paul was not able to save any money, there is a good chance that he will not do it in the future and then Jack’s money that could be used in a productive manner, would be wasted. Paul thinks that after the vacation he will repay his obligations. But how does he intend to do it? After all, he will not increase his earnings or productivity. For him it will be better if he first puts some money aside and spend it later as in this situation he will not have to pay the interest which he offered himself. The loan for consumption means that Paul borrows money from his future prosperity and with interest! He lives more comfortably now at the expense of belt-tightening in the future. And as everyone knows, it’s easy to get used to luxury. Much harder thing to do is to get back from the luxuries to the previous state. Therefore, human nature itself shows that it is better to save first and spend later.
The loan is beneficial for both sides, when it’s used to increase productivity. Such loan is also good for the economic growth. Consumer loans do not increase productivity and are a burden for people who take it. Nowadays, a consumer loan, which is very hard to avoid, is a mortgage. I dedicate a few words on this issue that you can read at econclips.com. If you don’t want to miss our next videos -like our Facebook page, and subscribe to our channel. Links can be found in the description below.