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Should You Take Out a Personal Loan When You Have Money in Savings?

The Motley Fool
The Motley Fool
 2022-01-24

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There may come a point when you need access to a pile of money, whether it's to tackle an unplanned expense or to take on a big project like home renovations . If you have money in savings , you might assume your best bet is to raid that account rather than borrow. But in some cases, borrowing affordably may be a better alternative to taking too much cash out of your personal reserves.

When a personal loan pays

A personal loan allows you to borrow money for any reason you want (as opposed to mortgages and auto loans, which allow you to borrow for the express purpose of financing a home or a vehicle, respectively). As such, personal loans are quite flexible. They also tend to offer relatively competitive interest rates -- meaning, you'll generally pay a lot less interest on a personal loan than what a credit card will charge you.

If you have a need for money, and you have some in savings, you may be tempted to dip into your bank account and take out a chunk of cash. But if doing so will leave you short in a future emergency situation, then it could pay to take out a personal loan instead.

Imagine you spend $3,000 a month on essential living costs and have $10,000 in your savings for emergency purposes. If you need $2,000 to buy furniture, and you remove that money from your savings, you'll whittle your balance down to $8,000.

At that point, you'll be below the minimum recommended threshold for emergency savings. Generally, you're advised to have enough money in savings to cover at least three months of essential bills. In that situation, a personal loan could make sense -- especially since the expense in question is not an emergency.

You may also decide to take out a personal loan so you get the peace of mind of leaving your savings alone. Say you have $20,000 in savings, which is enough to cover around six months of essential living costs. If you want or need $3,000 to tackle a home improvement or repair, and you'd feel better not tapping your savings, then it's perfectly reasonable to take out a personal loan, especially if you qualify for a competitive interest rate on the sum you're looking to borrow.

It's all about financial flexibility

Not only are personal loans a flexible financial product (in that you can use your loan proceeds for any purpose), but they could also give you more financial flexibility. You may want to retain a higher savings balance not just for protection against unplanned bills, but also, to make it possible to pursue different goals, like starting a business or buying a second home . If a personal loan allows you to keep your cash reserves intact, there's nothing wrong with taking one out provided the interest on it isn't excessive -- which, if your credit score is in good shape, it probably won't be.

Now if you're looking at paying a higher interest rate on a personal loan, then at that point, it could pay to rely on your savings. But if you shop around for a personal loan, you might manage to snag an interest rate that allows borrowing to make sense.

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