Is it possible to secure a personal loan when you’ve got money in your savings account?
For many, the primary motivation behind saving money is to ensure they have enough funds to handle emergencies, renovations, appliance purchases, furniture, and other significant expenditures.
The general idea, thus, is that in the face of an emergency or a sizable purchase, you should dip into your savings and then gradually replenish this fund over time.
However, another approach to managing these expenses is to take out a personal loan. This option can be somewhat controversial and undoubtedly comes with its own set of pros and cons.
The most common objection to this approach is clear: Why pay interest on a loan when you can access funds from your savings account at no cost?
Indeed, this reasoning is sound. Yet, in certain scenarios, opting for a personal loan even when you have savings can be a judicious choice. For some, it’s a way to build or improve their credit score, which isn’t possible without taking on some form of debt.
Additionally, a personal loan can serve as a tool for financial discipline, a concept we’ll explore further below.
Pros and Cons of Loans Over Savings
Opting for a personal loan despite having savings comes with various advantages and disadvantages.
Here are the key points you need to consider:
The primary objection: Why opt for a loan and pay interest when free money is available in your savings? This logic is compelling, but there are scenarios where a personal loan, despite available savings, could be a wise decision. Building or improving your credit score is one such scenario, as it’s impossible without taking on some form of debt.
Additionally, some might use it as a tool for financial discipline, a concept we’ll delve into more below.
Considerations for Choosing a Personal Loan Over Savings
Beyond the pros and cons, there are several factors to consider before choosing a personal loan over tapping into your savings:
- Fees: An essential factor to consider is whether the bank or credit union charges any processing fees or other types of fees for personal loans. Some financial institutions impose extra charges, which could significantly increase your total expenditure beyond just interest payments.
- Interest Rates: Having savings might help you secure a lower interest rate. However, high-interest rates can be off-putting, and you might decide against a personal loan in favor of using your savings.
- Loan Purpose: Personal loans can serve various purposes. Ensure your reason for borrowing is sound. An inability to repay on time could lead you to dip into your savings, which might not be ideal for something like a vacation loan.
When Could It Be a Good Idea?
There are certain circumstances under which taking out a personal loan, despite having savings, might be reasonable:
- Building Credit: If you’re looking to improve a poor or average credit rating, a personal loan can help. Some banks offer secured loans with minimum FICO scores requirements, providing a pathway to better credit.
- Emergency Fund Preservation: Financial experts often advise keeping at least three months’ worth of expenses in savings. If using savings would deplete this emergency fund, a personal loan might be a better option, ensuring you have sufficient funds for any unplanned emergencies.
When Might It Not Be a Good Idea?
Despite the advantages discussed, taking out a personal loan isn’t always the best move for everyone with savings.
- Substantial Savings: If you have ample funds to cover your planned expense while maintaining a solid emergency fund, a personal loan might be unnecessary.
- High Interest Rates: In times of rising interest rates, the cost of borrowing might outweigh the benefits, making it wise to utilize savings instead.
Alternatives
Certainly, there are viable alternatives to personal loans when you have savings:
- Securities Loans: You could leverage your investment account for a loan, allowing you to continue earning dividends without withdrawing funds, potentially offsetting the cost of the loan.
- Secured Credit Cards: If boosting your credit score is the goal, a secured credit card might be a better option, requiring only a small deposit and potentially avoiding interest charges by paying off the balance in full each month.