Emergency Fund vs. Personal Loan: Which option is best for your financial crisis? | Mint

An emergency crisis can come at any point in your life. In these times, you may require urgent financial assistance. Personal loans offer you with quick cash and flexible repayment tenure based on your credit score. However, it is important to understand whether or not you should take a personal loan or utilise emergency funds in such situations.

What are emergency funds?

An emergency fund is a separate amount of money set aside especially for use when there is an emergency. These funds are usually kept in separate accounts which may be savings accounts or easy liquid assets which can be used as an emergency fund when needed. Emergency funds assist you in coping with unpredictable situations that require cash. With these you can save yourself from borrowing loans and get into unnecessary financial burden.

Advantages of emergency funds

Unexpected medical costs: Medical emergencies come with hefty expenditure which sometimes can be extremely hard to bear. In this case, an emergency fund guarantees that you have extra cash in hand which you can spend on these expenses rather than impacting your regular salary.

Job loss or income disruptions: Fluctuations of job security often result in either termination or reduction in your salary. Emergency funds help you stay financially secure in these scenarios. These funds can aid you for some period until you get a new job or normalise your earnings.

Home or vehicle repairs: Unexpected house repairs such as a leaking roof, or car breakdown can occur any time. In these scenarios, emergency funds help you pay these sudden repairs without needing to borrow any loan.

Family emergencies: Emergency travel or other situations involving a family may come up when least expected. With emergency funds, you can access quick cash and travel without any financial burden to repay and fulfil your family duties stress-free.

What is a personal loan?

A personal loan is an unsecured type of loan which does not require collateral and is given to you for miscellaneous expenses. These types of loans pay close attention to your credit score and evaluate your creditworthiness before offering you a loan. Although personal loans are quite quick to avail, these types of loans attract high interest rates as compared to other types of loans in the market.

Advantages of personal loans

Protect savings: Getting a personal loan can be a good option if your total savings will completely get exhausted in case of an emergency.

Manage large expenses: You can easily distribute major expenses across various periods and conveniently pay them off in regular instalments.

Tax advantages: Getting a personal loan can also help you in saving tax in some cases. Interest on some kinds of personal loan such as home or car falls under tax benefit. Hence, you can easily avail this advantage and save on taxes with your personal loan.

Address urgent needs: It helps you to get fast and easy access to funds which you may require for emergencies such as urgent travel, surgery and long term illness.

Simplify debt repayment: Debt consolidation becomes extremely convenient with personal loans. You can repay your existing debts with a personal loan and then just pay on a single EMI of your personal loan in EMIs at your convenience.

Emergency funds vs personal loans

Before you decide on choosing emergency funds or taking out a personal loan, you need to consider a few aspects. If you have sufficient emergency funds available which will not impact your current cashflow, then using the funds is the best option.

However, in other scenarios, you should first calculate the cost of the loan and particularly the interest rate charged on the principal amount and check how much financial pressure you will be in after taking the loan.

You must also evaluate the conditions and how soon you require the money and then only make a decision on whether a personal loan is really what you require for your case. You can also do a mix of both.

This means that you can take a personal loan if it is at a low interest rate and then use the emergency funds to repay the EMIs on time. With this, you will not only build your credit score but also will be able to access larger amounts as per your needs without worrying about repayment failures.

Finally, before you make any decision, you should study the financial implications with respect to your income and capabilities so that you take measures for the future and make informed decisions while avoiding debt traps.