Financial emergencies can happen suddenly and without any warning—whether it’s a serious illness, losing your job, a car breaking down, or a surprise home repair. When faced with such situations, many people find themselves needing to make a quick decision: should they use the money they’ve saved in an emergency fund, or should they apply for a personal loan? Both choices come with their own set of benefits and downsides, and the most suitable option depends on your current financial situation and the urgency or severity of the crisis. Let us first understand more about emergency funds and personal loan.
What is Emergency Fund?
An emergency fund is a financial safety net designed to cover unexpected expenses or financial emergencies. Financial experts usually suggest keeping enough to cover three to six months of essential living costs. This money should be stored in an account that’s easy to access, like a high-yield savings account, so it’s readily available when needed.
What is personal loan?
A personal loan is a kind of loan that doesn’t require collateral and can be used for a wide range of needs. It usually has a set interest rate, a defined repayment period, and fixed monthly payments. Whether you’re approved depends on factors like your credit score, income level, and how much debt you already have compared to your income.
Pros and Cons of Using an Emergency Fund
| Type | Advantages | Disadvantages |
| Emergency Fund | Immediate access to funds during emergency | Takes time to build up |
| No interest or debt | Funds may be limited | |
| Provides financial security | Requires discipline to maintain | |
| Encourages saving habits | ||
| Personal Loan | Quick access to large sum of money | Interest and fees apply |
| Fixed repayment schedule | Increases debt burden | |
| Can help build good credit score if paid on time | Requires good credit for favourable terms | |
| No need for collateral (unsecured) | Late payments can hurt credit score |
Let us take an example of unexpected medical expenses:
| Factor | Emergency Fund | Personal Loan |
| Expense Amount | Rs. 1,00,000 | Rs. 1,00,000 |
| Source of funds | From personal emergency savings | Loan from a bank/NBFC |
| Interest Rate | 0% (no cost, it’s your own money) | 12% per annum |
| Loan Tenure | Not Applicable | 2 years |
| Monthly EMI | Not Applicable | Rs. 4,707 |
| Total Repayment Amount | Rs. 1,00,000 | Rs. 1,12,976 |
| Total Interest Paid | Rs. 0 | Rs. 12,976 |
| Financial Impact | No additional cost or debt | Increases monthly burden and total cost |
| Approval Needed | No | Yes- based on creditworthiness |
Factor Influencing Selection:
Based on the type of need, either a loan or an emergency fund can be used. If the expense is unforeseen but there is a possibility of more such unexpected costs in the near future, it’s wise not to completely exhaust your emergency fund. In such cases, using a personal loan to cover part of the expense while preserving some of your savings can be a more balanced approach.
Conclusion:
When faced with a financial emergency, deciding between using your emergency fund or taking a personal loan depends on multiple factors, including the nature and urgency of the expense, your current financial health, and future financial uncertainties. An emergency fund offers immediate, interest-free access to your own savings, helping you avoid debt and maintain financial stability. However, if using the entire fund could leave you vulnerable to future emergencies, a personal loan despite its interest and repayment obligations can serve as a useful supplement. Ultimately, a thoughtful and balanced approach, possibly combining both options, can help you manage the crisis effectively without compromising long-term financial well-being.
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The article is authored by Ms. Ritika Sharma from Team RichVik.