When facing a large or unexpected purchase, you have two choices. You can fund your purchase by taking out bank loans or borrowing from your savings account. Which is the better option? Join us as we explore the pros and cons of savings vs. loans for significant life expenses and how each option might impact your future goals.
Advantages and Disadvantages of Borrowing from Your Savings
Tapping into your savings offers several advantages over taking out a personal loan or line of credit — but some risks are still involved.
Pro: You Can Avoid Interest Fees
Tapping into your savings can help you avoid the interest fees associated with personal loans or a personal line of credit. You can repay your savings account over time without paying interest charges.
Pro: You Can Gain Bargaining Power
Paying in cash can also enhance your bargaining power. Some retailers and medical providers will offer discounts if you pay in cash, which can help you secure a better price for goods and services.
Con: You Could Hurt Your Savings Strategy
Dipping into your savings account may work for the short term, but if you don’t pay yourself back right away, it can impact your long-term goals, such as retirement planning. It can also deplete your savings to the point that you can’t cover emergency expenses, pushing you to rely on your credit card for future purchases.
Con: You May Face Penalties
If you have money in a certificate of deposit account, you may face penalties for withdrawing the money before the mature date. Certificate of deposit rates are designed to help you build wealth by saving. Removing money from the account prevents you from building short-term wealth.
Advantages and Disadvantages of Taking Out a Loan
Loans have their own pros and cons. Here are some factors that can influence your decision to pursue a loan or a line of credit.
Pro: You’ll Have Access to the Funds You Need
Some purchases can’t be completed without exhausting your savings, or they are too large to pay for all at once. Home and auto loans are good examples; buyers can use loan programs to obtain the money they need to make a significant purchase.
Pro: You Can Spread Out Payments over Time
Most loans come with flexible repayment terms, which allow you to spread your payments out over time. This option keeps your premiums low and helps you fit the purchase into your budget.
Con: It Will Raise Your Debt-to-Income Ratio
Taking out a loan will raise your debt-to-income ratio, which is the amount of money you owe versus the amount of money you bring in. Lenders commonly look at this metric when they consider you for future loan applications, so if you plan to take out a second loan soon, your present loan can jeopardize your eligibility.
Con: You’ll Have to Pay Interest
When you repay a loan, you’ll have to repay the principal (the amount you borrow) plus any interest. The exact interest rate can vary by lender and by your personal financial history, but this will be more costly than withdrawing from savings.
When to Choose a Loan
Your most regular purchases should be made by staying within your means. However, taking out a loan for large purchases makes sense when:
- You lack sufficient funds in your savings
- You don’t want to disrupt your retirement savings
- You find a lender who offers competitive rates and terms
The right balance between savings and loans can help you achieve greater financial security and maintain your long-term strategy.
Why Bank at CSB?
At Cleveland State Bank (CSB), we pride ourselves on merging financial services with support for our local community. We offer competitive rates for certificate of deposit (FDIC-insured) accounts, IRAs, and other financial vehicles. Contact us to learn more.