Apply for a Loan or Use up Savings? Make a Wise Choice.
One of the most common questions that people have about their money matters is if they should choose to take a loan for a big spend or use their savings instead. This becomes more complicated for the people who do have a decent enough amount saved up over a period of time. The decision is not an easy one, and we will need to consider many factors before arriving at a conclusion. You will have to keep your emotions aside in order to make a rational decision. There will be multiple factors to consider, including the actual cost involved if you have an emergency fund, as well as some other aspects. Let us start by looking at them one by one.
Compare the cost of capital: The real cost involved should be a key driver in making the decision of using saving vs. taking a loan. Start by looking at the return you are getting in interest on your money saved. If money is kept in a Saving Account, you are getting rather low interest on that. If your money is invested in Fixed Deposits, stock markets, or any other investment vehicle, you are probably drawing better returns.
Compare the return on your investments to how much will the loan cost you. Comparing the interest rate is just one side of the picture. Loans come with processing fees and advance interest charges etc. Pre-payment of loans will also attract some charges. Then there are the charges involved in case of missed EMIs. All these factors should be carefully understood before making the decision.
Based upon all of the above, you may want to choose the option that will cost you the least in both Short Term and Long Term.
Check up on your emergency fund: A number of people tend to consolidate their saving with their emergency fund. Unless you have both of them marked as separate, you will start to feel a bit exposed by spending savings. Taking out a Personal Loan allows you to keep aside that saving for an emergency. At first, this may seem like a rather expensive way to save up for an emergency because of the high-interest rate on loan, but then you also have to consider that not having any savings at all is also an unacceptable financial situation. Sometimes you can use your overdraft account or a credit card as an emergency solution as well.
It is also important to be up to date on both your medical and life insurance. In case of an extreme situation, you can also consider restructuring the loan you took. Then again things may also turn out to be fine enough, and you may not encounter any emergency at all. It always pays to be responsible with your money, and you can also replenish your Savings Account if you remain disciplined. Live with the basics, and you can have your savings rebuilt or the loan repaid at a rapid pace.
Compare the effort involved: Effort involved might make it look like using the savings is a much simpler choice. If what you intend to buy can be bought on Credit Card, you can charge your card and pay it off from your savings, provided other factors remain the same. Yet there are many factors to consider here. Start with estimating the effort you took to save the money and compare it to the efforts involved in getting a loan. The picture suddenly becomes to look different. Saving the money is also more complicated psychologically than paying off a mortgage. People tend to develop an attachment to the saving they have accumulated. This makes it very difficult for them to let that money go. In case of people who have saved up money for a specific purpose, for example, to buy a car or an international holiday, things become all the more complicated.
On the contrary, you have to treat a loan EMI like an expense that you have to cover regardless of other things. People generally tend to put off savings when compared to other expenses. Simply put, saving up the money takes a lot more effort than paying off a loan because of flexibility in commitment levels involved.
Explore alternatives to your expense: This is the factor which comes like the joker in a pack of cards when you are faced with the choice between savings and loans. Consider the most common example, buying a car. A number of people save up for buying a car, and many more people tend to take out Car Loans. There is also a third choice. You can consider buying a used car. As opposed to using all your savings to buy a new car or taking a car on a big loan, you can consider buying a used car. Cars being a depreciating item cost you as low as half the price of a new car after 3-4 years. The choice becomes much simpler now; for example, you can keep all your saving with you, take out a Personal Loan, which will be about half the cost of a Car Loan and pay it off at a faster pace or with lesser EMI amount.
This way, your savings remain intact, you do not have to worry about Car Loan hypothecation and its removal, etc. You get your car in your name from day one, and there is no risk of the car being repossessed by the bank either.
The decision between using up your savings or taking out a loan is not an easy one. There is never a straightforward answer, and you have to keep many factors in mind. In-fact the best approach is to think of out-of-the-box solutions to the maximum possible extent. Remember that money management is not just about mathematical calculation. Financial decisions are as much a decision of heart as they are a decision of your head. The choice is never natural, so compare, research online, and discuss with your family and experts before you decide.
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