Emergency personal loan vs. emergency fund: Which is best for a large expense?
Benjamin Franklin famously opined that death and taxes are the only two certainties in life. Uncertainty is certain in life, and we can rarely predict what may happen. Emergency funds are a good way to plan for the unexpected, but they may not always be the best choice to handle a large, unplanned expense. In certain circumstances, personal loans can be a good alternative.
Many Americans struggle to manage unplanned expenses, with 63% of people being unable to handle a $400 expense, according to the Federal Reserve. Emergency loans are designed to provide quick access to funds for unexpected expenses, but it’s essential to understand the various types of emergency loans available. An emergency personal loan might seem like a convenient solution, but interest rates can easily reach 20% or higher, so it’s crucial to carefully evaluate this option before proceeding. This guide covers using a personal loan vs. emergency savings, what you must consider between the two, and which is best for certain circumstances.
Understanding emergency funds
Having adequate emergency savings is a key tenet of personal finance, but most situations are unique. Understanding the role emergency funds play in your financial life is crucial before deciding to access them.
What constitutes an adequate emergency fund?
Most financial experts recommend having an emergency fund that comprises three months’ worth of living expenses. This is to ensure you are prepared for emergency expenses and unexpected costs that may arise, such as medical bills or urgent home repairs. That is merely a starting point and is best-suited for a single individual with a stable income and no dependents.
If you have dependents or substantial financial obligations, you want to have six months of living expenses, and nine months if your income is irregular. As the Federal Reserve reported, only a minority of Americans can handle a $400 surprise expense. Furthermore, PYMNTS reports 35% of shoppers made an emergency purchase of at least $250 in the past year.
If possible, it’s prudent to continue building emergency savings to at least three months’ worth of living expenses, even when repaying debt.
Benefits of using emergency funds for large expenses
Using emergency funds for a large expense is often better than taking emergency personal loans. Here are some key reasons to access an emergency fund first.
No interest costs: Loans for unexpected expenses are typically accompanied by an interest charge. If you have average or worse credit, APRs can reach well over 20%. Using your emergency fund saves on interest.
Immediate accessibility: Personal loans typically have a paperwork and review process, which can take days or longer to receive approval. In most cases, you can access cash from an emergency fund the same or the next day.
No impact on credit score: Any time you request a loan, your credit score is impacted. A hard credit pull will lower your score, albeit temporarily, and your credit could take a hit depending on your repayments and credit utilization ratio.
Limitations of relying solely on emergency savings
Using your emergency fund isn’t always the best move. There are some drawbacks to consider, including:
Vulnerability to other emergencies: Avoiding a loan to pay for a surprise expense feels great, until it doesn’t. If using emergency savings leaves you exposed to further risk because you don’t have adequate savings, you may want to contemplate taking out an emergency personal loan. Depleting your emergency fund can leave you unprepared for future financial emergencies, such as unexpected medical bills or urgent car repairs.
Rebuilding timeline: If it’s going to take too long to restore your emergency fund, it may not be a wise choice. Ideally, you want to see solid progress towards rebuilding emergency savings within six to nine months.
How personal loans work for emergencies
Whenever you incur debt, it’s essential to understand how the process works and what’s expected of you. Applying for an emergency personal loan is no different. The loan application process typically involves completing required documentation accurately and quickly to ensure a smooth and timely approval. You can visit a brick-and-mortar bank branch to request a loan, or you can compare multiple online lenders simultaneously to find the best rate and terms.
After receiving loan approval, you typically receive a lump sum, and repayment begins immediately. Payments are commonly monthly and can last for six to seven years or less. Interest rates vary, depending on factors such as credit score, repayment terms, and amount borrowed.
For example, as of May 2025, the average interest rate on a 24-month loan was 11.57%, according to the Federal Reserve Bank of St. Louis. Additionally, some lenders may charge origination fees or application fees that can increase total indebtedness.
Opting for an online lender is often a smart choice when seeking the best personal loans, as many can provide quick access to funds, sometimes with funding as soon as the next business day, depending on the lender. Traditional banks, on the other hand, may take a week or longer to disburse loan funds. When exploring your options, it’s important to compare lenders carefully, review their loan terms—including interest rates, fees, and repayment schedules—and consider the convenience of completing the application online.
When deciding how much to borrow, be sure to select a loan amount that matches your needs without exceeding the maximum loan amounts offered by different lenders. Borrowing only what you need can help minimize interest costs and reduce the risk of overextending your finances.
Compare personal loan rates
Qualification requirements for personal loans
Credit score implications: Credit score plays a crucial role in securing a personal loan. Many lenders require a credit score of at least 670, often closer to 700, to qualify. The higher your score, the better loan terms and interest rates you are likely to receive. Lenders will also review your credit history and typically perform a credit check or hard credit inquiry during the application process. If your credit score is lower, obtaining a loan or securing a competitive interest rate may be challenging. Individuals with bad credit or low income might face additional hurdles and may be required to provide collateral to qualify for certain loans.
Income verification: Lenders usually require verification of your income before approving a loan. They may ask for pay stubs or tax returns. If you’re self-employed, they may ask for bank statements.
Debt-to-income considerations: Debt-to-income ratio reflects how much of your income goes toward debt, and includes anything from credit cards to a mortgage. For example, if you earn $5,000 monthly and $1,500 of that goes toward debt, your ratio is 30%. Lenders commonly view anything under 35% as healthy. The higher your ratio is, the more difficult it may be to get a competitive loan rate.
Head-to-head comparison: Emergency fund vs. personal loans
Whenever considering personal loans versus emergency funds for a large expense, it’s essential to compare interest costs with opportunity costs. Making an unwise choice can have serious implications for your finances in the future. When comparing emergency funds and personal loans, it’s important to understand the loan terms, repayment options, and available payment plans, as these factors can significantly affect your total cost and financial flexibility.
Cost analysis over time
Considering how a personal loan for an emergency vs using savings requires looking at the cost over time. You may determine that a personal loan will cost you $1,000 in interest over the life of the loan. Loans accrue interest over time, which increases the total amount paid compared to using your own savings.
On the other hand, your emergency fund may earn $150 in interest over the year for the same amount of cash. That’s your opportunity cost. Moreover, if you used some of your emergency savings to invest, the potential gains are also an opportunity cost.
Examining a simple example is a good way to understand interest costs. If you have a $10,000 surprise expense, withdrawing that cash from emergency savings will have zero cost, but your savings will drop.
Alternatively, if you obtain a $10,000 loan for three years with an APR of 11%, your monthly payments will be $327, resulting in a total cost of $11,772. The loan will cost $1,772 in interest. If that rate increases to 18%, the total cost rises to $12,948, representing $2,948 in interest.
Impact on financial flexibility
Adaptability is vital for personal finance. There’s little way to predict the future, and flexibility helps you handle what may come your way. Deciding between using emergency funds and a personal loan is no different.
Pulling cash from your emergency fund results in no new debt. If you can replenish savings relatively quickly, that provides flexibility.
The lack of monthly payments can be powerful, but it also comes at a cost. Taking out a loan preserves savings but adds a monthly payment. Missing payments can harm your credit score, and at the very least, additional debt may make it challenging to get other loans, such as a mortgage, particularly if your debt-to-income ratio is too high.
Credit score implications
Using cash from your emergency savings has no impact on a credit score. It’s your money, so you can use it as you wish. Needing to rebuild an emergency fund has no impact either.
The same is not true for getting an emergency expense loan. Applying for a loan will temporarily lower your credit, but it should rebound in short order. On-time payments can build a healthy credit mix and history, which may benefit you in the future. Unfortunately, a new loan may impact future borrowing needs, especially if you miss payments or carry too much debt.
When to choose emergency funds
Deciding between a personal loan vs. emergency fund depends on your specific situation. There’s no cookie-cutter solution, and how you feel about both also plays a role. Using emergency funds is typically wise in the following circumstances:
The expense is within fund capacity: The purpose of emergency funds is to have cash when the unforeseen happens. If you have more than enough to cover your needs, using your emergency fund is wise.
You can replenish funds quickly: Leaving yourself susceptible to problems isn’t typically prudent. If you have a stable job with a good income, allowing you to restore the savings in under a year, you may want to use the emergency fund.
When you want to avoid debt: Debt is an emotional issue, and some want to avoid it at all costs. Whether you don’t want the burden of debt or plan to get a loan for a specific goal, you may want to use your savings.
When to pursue a personal loan
Taking out an unsecured personal loan may not be your first choice, but in certain circumstances, it may make sense. Unsecured personal loans are commonly used for emergencies, but secured loans may be an option for those with bad credit or who can provide collateral. Obtaining a loan may be a wise decision in the following situations:
You don’t have enough savings: If you don’t have sufficient savings, applying for an emergency loan may not be an option. Don’t get a loan, though, if the expense is discretionary. Having extra cash on hand can help you avoid high-interest debt, so consider building your savings if possible.
The expense is unavoidable: Sometimes an emergency expense is unavoidable. You may need to replace a costly and essential appliance. A loan could be wise in this case. Some people may turn to title loans or payday loans for quick cash, but these options often come with higher interest rates and risks, including the potential for repossession or rollover fees.
You can get a competitive APR: Interest rates vary widely, largely depending on your credit score. If you have good credit and can secure a low APR loan, it may be worth pursuing. Cash advances, either from credit cards or paycheck advances, can provide extra cash in emergencies, but may accrue interest immediately and often come with additional fees.
When considering your options, seeking financial help from credit unions can also be beneficial, as they may offer more favorable terms for emergency loans compared to other lenders. If you need to get an emergency loan, compare your options, understand the approval process, and review repayment terms before applying. Only borrow money that you can afford to repay to avoid further financial difficulties.
Bottom line
Unexpected events rarely give fair warning, and it’s essential to make a wise decision to manage the financial consequences. Approaching the situation depends on your unique personal circumstances and financial situation. Using a personal loan may seem best at times, but it can present other long-term problems. Accessing your emergency fund can be helpful, but it may leave you vulnerable to other financial issues. Upon deciding which is best, make a plan to bolster your finances and build your emergency fund to deal with what life throws at you next.
