Is it ever worth taking out a loan if you could save instead?

sunlight432

Hi everyone,

I was having a discussion with a friend and wondered what people's views are.

If you know you'll need to make a fairly big purchase in the next 6–12 months (car repairs, home improvements, replacing a boiler etc.), would you rather save up first, even if it means waiting, or take out a low-interest personal loan and spread the cost?

Assuming the repayments are affordable, is there ever a case where borrowing makes more sense, or do you avoid loans wherever possible?

I'm interested to hear how others approach it and whether your views have changed over the years.

Exodi

I think this can be quite nuanced depending on circumstances.

Pragmatically, it's generally more sensible to save up for a purchase, instead of using debt - as it both demonstrates the purchase was affordable but also fully considered.

Financially and mathematically it depends on what rates you might get on the debt, compared to what rates/returns you might get on the same amount of capital.

A simple example of this, is that if you had £1k in your pocket and wanted a £1k item, if you put the £1k in a savings account paying 5% interest and bought the item with a 0% credit card, you'd benefit £50 per year.

To give a slightly more complicated personal example, I currently have a large mortgage debt of ~4.5% with a remaining term of around 2 decades. I do not overpay my mortgage, as I expect the returns on my investments to be higher than ~4.5%. Fortunately for me, my 5 year XIRR is around triple that at 13.1%. In layman's terms that means if I used £1000 to overpay my mortgage, I would save £45 in interest per year, whereas over the past 5 years, by having it invested I've received £131 in returns per year.

The options and rates people might have available to them differ, so unfortunately it's not possible to give a definitive yes/no answer, however interest rates on debt are generally higher than on savings so it usually makes sense to buy with cash where possible.

maman

Years ago, when had a young family and just starting out on careers, we have taken out a bank loan for a car.

These days, we fortunately have enough savings built up so that we wouldn't need to.

To address the examples you gave then, if I had no other option, I would take out a loan for car repairs or a broken boiler as they are likely to be essentials that can't wait. For home improvements, I'd try to save up.

Emmia

I have the savings but used a 0% credit card to pay for an OU course I'm currently doing, which I'm paying off in monthly installments - it's not a huge purchase in some ways ~£3k, and it's cheaper than taking the hit on the interest by using savings.

BridgetTheCat

I’m a big fan of saving up. For one thing it reduces impulse buying, giving me time to consider do I really want it, and is it worth the money. For another you get interest while you’re saving. I’ve bought a few things on 0% loans before and I absolutely hated seeing the money go out of my account every month. Even though intellectually I knew I wasn’t paying any more than a cash purchase, emotionally and psychologically I felt like I couldn’t enjoy it until it was fully paid off.