Using your Savings vs. taking out a Loan

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Managing your money amid a crisis is a difficult task that needs a lot of effort, discipline, and patience. Whether you need money to purchase a new house, renovate an existing one, plan a wedding, vacation, pursue further education overseas, or deal with a medical emergency, you’ll need money to deal with the problem at hand. While some of these costs may be budgeted, others, such as coping with a medical emergency, are beyond your control and can occur at any moment.

Pros and Cons of Using Savings

Pros of Using Savings

  • Interest-Free Purchase 

If you want to buy an iPhone or another expensive item and decide to take out a personal loan to do so, you will have to pay interest on the loan. As a result, you’ll wind up paying the Amount X plus interest on your transaction in total. If you opt to buy it with your savings, you will not have to pay any interest and will simply have to pay the product’s real cost.

  • Stress 

Spending from your savings may appear to be a hardship at first, but it relieves you of the worry of repaying the debt over the course of the loan’s term. You may also set a spending limit for yourself since you know how much money you have saved and how much you can spend.

  • Credit Scores become irrelevant 

If you use your savings to pay a payment or make a purchase, your credit score becomes useless and has no influence on your spending ability. This is not the case with loans, since most banks demand consumers to have excellent credit ratings in order to get approved.

  • Better Financial Wisdom 

When you know you’ll be financing your present purchase with a loan that you’ll have to return in the future, it’s easy to get into a debt trap. If you don’t have a strong sense of financial discipline, this might lead to irresponsible and unnecessary spending. Savings, on the other hand, can help you become more financially disciplined by restricting your spending to what you can afford and not going over your budget.

Cons of Using Savings

  • Savings Limit the Affordability 

One of the most significant disadvantages of saving is that you can only spend what you’ve saved. People also urge you to not spend all of your funds at once and to preserve a backup. Additionally, this restricts your finances and desires to the amount of your savings, which isn’t always possible.

  • Dissolving Savings Takes Long 

Very few people keep their saved amount in bank accounts and prefer to keep them invested in multiple forms like shares, mutual funds, real estate, gold, and bonds. Dissolving these savings into cash takes time and thus is a long wait which isn’t really a feasible choice when you need instant funds.

  • A Long-Drawn Procedure

Very few people keep all their savings in their bank account and prefer to invest it in different forms, like shares, bonds, mutual funds, real estate, and gold. While these are safe investments, it usually takes a few days to access their liquidity when needed. Thus, if you need the amount urgently, digging into savings might not be the best idea.  

  • Interrupts Future Plans 

If you’ve been saving to buy a new car, for home renovation, or to buy an expensive gadget/appliance, parting with that saving to meet another cause is a little daunting. It also hampers your future plans as you’ll have to start over again to save for the same cause. In such situations, going for a loan is a wise choice.

Pros and Cons of Taking a Loan 

Pros of Taking a Loan 

Taking a loan might seem counter-intuitive if you have substantial savings, but it does come with a few advantages:

  • Less expensive in the Long-Run 

In the short term, a loan is obviously more expensive than utilising your savings, but in the long run, your investments are likely to yield larger returns than the amount you wind up paying in interest on the loan. For example, if you sell a property that increases in value by 10% each year, you would lose more money than if you pay an interest rate of 8% on a loan.

  • Helps in reducing the Tax Burden

There is a hidden benefit of taking a debt; i.e., it helps in reducing the tax burden. This is because the cost of interest from taking loan reduces the taxable income and curbs down the tax amount. Thus, a person can save a considerable amount as tax when taking a loan and can offset the cost of interest by making use of the several deductions in the Income Tax Act of India related to loans. 

  • No Restriction on End-Use 

Unlike a home loan or car loan, a personal loan doesn’t have any restriction on the end-use of the loan amount. Having the freedom to use the loan amount any way results in greater flexibility in spending.

  • Instills Financial Discipline 

Taking on debt necessitates discipline in terms of effectively managing financial costs, particularly in terms of investing and spending in the early days until a person earns enough to return it. As a result, one of the benefits of debt is that it encourages the borrower maximise every dollar and live a financially disciplined life.

  • Multiple-purpose usage of Personal Loans

While most loans are sanctioned for specific uses – purchasing a car or house, higher education, or starting a business – personal loans offer a variety of uses to their borrowers. There are usually no limitations on how borrowers choose to spend their personal loan amount, which means greater flexibility in spending. 

Cons of Taking a Loan 

Alongside the benefits, there are several drawbacks of borrowing a loan as well. Here are some of them: 

  • Imposes the burden of EMI

Loans come with EMIs that must be paid over months, if not years. In practice, this means that the impact of one big purchase is felt for as long as the loan isn’t repaid completely. This is obviously not an ideal situation, as a part of your earnings is diverted to pay EMIs. 

  • High Barriers 

Most banks and financial institutions require their customers to submit collateral or securities against their loan amount. Furthermore, they also require that their borrowers have a high CIBIL score. In their absence, taking a loan can be really challenging; which means that there are several barriers to taking a loan. 

  • Interest Rates can increase Over Time 

Most banks and financial institutions revise their interest rates periodically as per the RBI policy to encourage or discourage credit in the economy. This means that customers who have existing loans also pay variable EMIs and the interest rate can vary over time as well. Thus, you may end up paying a little more in interest than planned over the years. 

  • Additional Charges and Penalties

Most banks and financial institutions levy charges like processing fees, prepayment charges, and late penalties on their customers. These can improve the overall cost of the loan and can become prohibitively higher for some customers.