In the absence of an identifiable contingency fund kept aside for such purposes, there are two solutions: take a personal loan or break your savings
Emergencies crop up every now and then and you may find you need a lump sum, which you don’t have lying idle in your bank account. In the absence of an identifiable contingency fund kept aside for such purposes, there are two solutions: take a personal loan or break your savings. Here are four parameters to make the right choice.
Personal loans have high costs: the interest you pay on the loan amount. Currently, a personal loan can cost between 12% and 22% per annum. The cost of breaking your savings is the earnings you forego on them. The 1-year fixed deposit rate now is about 7.5%. For a short-term income fund, annualised earning is 9-9.5%.
If you take a personal loan, there are processing charges of 2-3% that you will have to bear. For instance, the processing fee on a Rs5 lakh personal loan at 2% would cost you Rs10,000. Premature redemption of a fixed deposit has a lower cost—a penalty of 1% on interest earned. Again, it is cheaper to break the FD than to take a loan.
Loan : Bad
Savings : Good
Taking a personal loan means adding an additional burden of repayment that can put pressure on your monthly cash flow. You will have an additional equated monthly instalment (EMI) to pay for the loan. On the other hand, breaking your savings won’t have an impact on your cash flow and daily expenditures.
Taking a personal loan doesn’t hit your long-term investment objectives. Money put aside in investments is earmarked for a future goal and taking a loan will not disturb such goals. If you break any of your investments to pay for an emergency, then you would have to save more in the future to make up for the lost allocation.
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