Life is unpredictable and unexpected financial emergencies can arise at any moment. To manage such situations, two common options often considered by individuals are emergency funds and personal loans. Each option has its pros and cons, and knowing when to use each can make a significant difference in your financial well-being.

When you need funds, you have two options, whether to use your emergency funds or borrow from financial institutions for which the terms and conditions may vary depending on your credit worthiness such as your income, repayment history, credit score and other eligibility criteria. Let us understand both emergency funds and a personal loan, and know when to use each one of them.

Emergency Funds

Emergency funds are savings specifically set aside to cover unexpected expenses or financial emergencies. These funds are typically kept in easily accessible accounts like savings accounts or liquid investments. The primary purpose of emergency funds is to provide a financial cushion to deal with unforeseen circumstances without resorting to debt.

Also Read: When is the right time to increase your credit card limit?

When to Use Emergency Funds:

1. Unforeseen Medical Expenses: In India, healthcare costs can be substantial, and unexpected medical emergencies can quickly drain your finances. Having an emergency fund can help cover these expenses without putting a strain on your budget.

2. Job Loss or Income Interruption: Economic uncertainties are not uncommon, and losing a job or experiencing a sudden reduction in income can be financially devastating. Emergency funds can provide a temporary source of income until you secure a new job or stabilize your finances.

3. Home or Vehicle Repairs: Whether it’s a leaky roof, a broken-down car, or any other unexpected repair, having funds readily available can prevent you from having to take on debt to address these issues.

4. Family Emergencies: Sometimes, you may need to travel urgently to attend to a family member in need or deal with other unforeseen family emergencies. Emergency funds can cover travel expenses and other associated costs.

Personal Loans

Personal loans are unsecured loans offered by banks, financial institutions, or online lenders. Unlike specific loans like home loans or car loans, personal loans can be used for various purposes, including emergencies. Personal loans provide quick access to funds, but they come with interest rates and repayment terms that can significantly impact your finances in the long run.

When to Use Personal Loans:

1. Immediate Financial Needs: If you don’t have sufficient emergency savings and are faced with an urgent financial need, such as medical expenses or repairing essential appliances, a personal loan can provide the necessary funds quickly.

2. Consolidating High-Interest Debt: If you have existing debts with high-interest rates, consolidating them into a personal loan with a lower interest rate can help you save money on interest payments and simplify your debt repayment strategy.

3. Opportunities with High Returns: Sometimes, there are investment or business opportunities that require immediate funding and have the potential for high returns. In such cases, taking a personal loan may be justified if you have a solid plan for utilizing the funds and generating a higher return on investment.

Choosing the Right Option

When faced with a financial emergency, it’s essential to evaluate your options carefully before deciding. Here are some factors to consider:

Adhil Shetty, CEO, Bankbazaar.com, says, “Compare the cost of borrowing through a personal loan (interest rates, fees) with the opportunity cost of using emergency funds (potential lost interest or investment returns). It is also important to consider your ability to repay the loan within the stipulated time-frame. Taking on debt that you cannot afford to repay can lead to financial stress and further problems down the line. You must also assess your risk tolerance and comfort level with debt.”

“While emergency funds provide a safety net without incurring debt, personal loans involve borrowing and repayment obligations. Additionally, you must evaluate the impact of using emergency funds or taking a personal loan on your long-term financial goals, such as retirement savings etc.,” adds Shetty.

Whenever you need to take a decision, it’s essential to strike a balance between maintaining adequate emergency savings and using credit responsibly to address immediate financial needs.