Should I Take a Loan or Use my own Savings?
The Save or Borrow Decision
So you have been diligently putting aside 10% of your earnings every month and now you have a nice lump sum saving that is earning a modest interest in a financial institution. Something comes up and you need some cash right away. What should you do? Should you take a loan or should you use your savings? Here are some of the things you should consider when making your decision assuming that you qualify for a loan.
The Purpose of Your Savings
Why were you saving in the first place? There are myriads of reasons why you could have been saving. I am going to assume that you were saving towards a specific goal such as to build an emergency fund or to accumulate enough for the down payment on a car or on a home, saving for college, saving in order to be able to capitalize on a potential business opportunity, saving as a cushion in the event that you lose your major source of income or saving to purchase the latest gadget. Whatever the reason for your saving, the purpose of your savings is an important consideration in your decision to use what you have saved.
Let Your Voice Be Heard
What is your most important saving goal right now?
Never Spend Emergency Funds on Non-emergencies
It is my opinion that emergency funds should never be spent on anything except emergencies. Since we can’t tell what the future holds, we should always try to have some money put aside for emergencies such as illness. However, if and when that emergency happens, you will have some money on hand to deal with it. So if you have an emergency fund and you have an emergency, my advice would be to use your savings. While you could take a loan, bear in mind that there are interest costs and other fees such as processing and commitment fees that you would have to pay if you take a loan. By using your own savings, you would save yourself the extra fees. In addition, taking a loan would mean that you would become obligated to making regular payments as agreed with the lender. If you use your savings however, be sure to begin to build those savings again as soon as you are able to restart. The good thing about emergencies is that they don’t (or shouldn’t) happen too often; giving you adequate time to rebuild your fund if you had to spend it. However, the closer you are to retirement, the less willing you should be to take on any debt. You should instead concentrate on building your nest egg since you won't have a lot of time to rebuild your savings if you choose to use them for other purposes.
Use savings for what they were earmarked
Generally speaking, if you were savings towards something and you now have the opportunity to use those funds for what they were earmarked, go ahead and use them for their intended purpose. This may not be the case however. Let’s say you were saving for the down payment on your home and an emergency comes up for which you need funds. My advice in such a case would be to take a loan. It is difficult to save towards major purchases such as a home or towards college and you should remain focused on reaching such savings goals. If you use these funds for an emergency or for any other purpose, you would be setting yourself way back and would have to begin saving from scratch again. This would be a major opportunity cost to you. Imagine what the cost would be if you use your college fund and have to start savings again from scratch while the cost of going to college continues to rise and while you still remain unqualified to make the salary or income that you would love to be making. By taking a loan, you would be able to deal with the emergency and still have savings set aside towards making major purchases. Although there would be costs involved, they would still not amount to the opportunity costs that spending your savings would.
How to set up an emergency Fund
What to Consider when taking a Loan
The Purpose of the Loan
While credit cards and payday loans are a dime a dozen, I don’t subscribe to borrowing for consumption purposes. It just amounts to being penny wise and pound foolish. And yes, credit cards are loans just in case you didn’t realize it. If there is a gadget that you want and you have some savings that are not earmarked for anything specific, you should use your savings to purchase that item. If you want to take a vacation, please use your savings instead of taking a loan. While it is very easy to charge it to your credit card, you should consider the high interest charges attached to credit cards and other consumer loans such as payday loans and hire purchases. If you see a credit card being advertised at 14% APR, you should be aware that that rate is an annualized rate and does not reflect the fact that your rate increases daily if you have unpaid balances. Although you can find some 0% credit cards, you usually have to have excellent credit to qualify for those and the rates revert to normal rates after periods of between 6 to 18 months usually. In addition, you may still have to pay balance transfer fees to pay off the fees that you might have on other credit cards.
Borrow for Productive Purposes
On the other hand, it is usually beneficial to borrow for productive purposes. A productive purpose would include anything that is going to allow you to make a return on the money that you borrow. However, that return must be greater than the return that you are making on your current savings and also implicitly greater than the interest that you would be required to pay on that loan. A productive purpose usually includes borrowing for investment purposes that have the potential to bring you excellent returns. Good investments include promising business ventures that you are fully capable of operating profitably. This is essentially leveraging other people’s money to your advantage. If you are able to put someone else’s money to work for you while making an excellent return, by all means do so. Remember though that you should make all efforts to meet the loan obligations as agreed since any negative deviations from the payment schedule will negatively affect your credit rating. It is in your best interest to do everything to ensure that the returns on your investment meet or exceed your expectations. While you may not have much control about what is happening in the society, you do have control over the types of business ventures that you choose to become involved in. While the riskier ventures usually promise higher returns, there are no guarantees so prudence should be exercised.