Credit Card vs Personal Loan
Sometimes you just have to borrow money. When the need strikes, you have two main options at your disposal: credit cards and personal loans. Both offer solutions to your immediate cash flow needs, and when managed properly, they can also help you build credit and improve your credit rating. However, they each carry their own advantages and drawbacks.
To decide which type of debt is better for your situation, you’ll need to assess the details and consider them in light of each option’s pros and cons. Credit cards are better in some situations, while loans make more sense in others. It all depends on how much money you need, how quickly you’ll be able to repay it, and how much other debt you’re carrying.
Credit Card Basics
Credit cards offer flexibility and convenience: you can use them to pay for in-person and online purchases, and they also offer cash advance features. This gives you a range of financing options that can help you cover everyday and one-time expenses.
When you use a credit card to finance purchases or take cash advances, you will accrue a balance that must be repaid. However, you can repay as little or as much as you are able each month as long as you meet your required minimum. That versatility may help you manage your other financial commitments a little more easily. Even better, many credit cards come with no-interest or low-interest introductory periods, allowing you to take maximum advantage of the buying power they offer.
When Are Credit Cards a Good Option for Borrowing Money?
Credit cards are best used in the following borrowing situations:
- You need a way to pay for a flurry of smaller purchases or expenses that you don’t have cash on hand to cover
- Your income is sufficient to pay off your balance in full (or close to it) each month
- You’re being offered a low-interest or no-interest credit card
- You need the flexibility of paying down the debt in differing amounts each month
- You cannot qualify for a personal loan, or only qualify for high-interest loans with disadvantageous terms
Remember: most credit cards only charge interest on balances that are not paid in full by the end of the monthly billing cycle. If you repay 100% of your balance by the time your payment comes due, you can essentially borrow money for practically no cost.
Pitfalls and Drawbacks of Credit Cards
Despite their many advantages, credit cards also come with some significant drawbacks. These are most apparent when interest charges apply to your balance. Interest adds up quickly, and you can wind up spinning your wheels in debt if you aren’t careful. That’s why it’s important to pay down as much of your balance as you can each month. If you’re only making minimum payments, interest will keep adding up and you will end up with an expensive and cumbersome long-term debt.
Other disadvantages of credit cards include:
- Annual fees and late payment fees can make credit card debt even more expensive
- Some credit card companies will increase your credit limit without you requesting it, which can lead you to rack up more debt than you can afford to carry
- Other credit card companies allow you to exceed your limit, then hit you with exorbitant charges for doing so
- Without a very good or excellent credit rating, you will only qualify for higher-interest cards that pose greater risk
- High interest rates usually apply to cash advances, and interest starts adding up immediately
The bottom line: credit cards offer excellent versatility, but if you need a lump sum to finance a large purchase or major expense, they are not usually the best option.
Personal Loan Basics
Banks, credit unions, and specialized lenders can offer personal loans to borrowers. Funds are distributed in a single lump sum, known as the loan principal, which you are then free to use as you see fit. Lenders make money by charging interest on the principal, which is usually calculated as an annual percentage rate (APR). You will be expected to repay the loan over a period of time known as the loan term, and most loans require fixed monthly payments that cover the principal plus the interest.
Some lenders charge additional fees, such as:
- Origination fees, which lenders usually calculate as a set percentage of the loan principal
- Early termination fees to make up for the interest the lender will lose if you pay back the loan ahead of schedule
- Late payment or missed payment fees
Always make sure you are fully aware of all applicable fees and charges when applying for a loan.
When Are Personal Loans a Good Option for Borrowing Money?
Most borrowers turn to personal loan lenders when they need access to a larger lump sum. Personal finance experts typically recommend loans in the following situations:
- You qualify for low personal loan interest rates that allow you to pay off higher-interest debt (this is known as debt consolidation)
- You need to finance a major purchase or significant expense
- You have a stable income source that can easily absorb fixed monthly loan payments
- Your credit rating is in the very good to excellent range
- You’re committing the money to a renovation project that will increase the resale value of your home, or to some other asset that will appreciate in value
The personal loan application process is more involved, as you will need to fill in detailed information forms and provide proof of income. Lenders then evaluate your case and make a decision. As an alternative to a personal loan, you can also apply for a line of credit with your bank or credit union. Lines of credit combine the flexible spending of a credit card with the lump-sum cash availability of a personal loan, and they can be an excellent option if you qualify.
Pitfalls and Drawbacks of Personal Loans
The repayment terms attached to most personal loans are not as flexible as the ones that apply to credit cards. You will have to pay back the loan in fixed, regular instalments, and missing a payment will create immediate problems for your credit rating. Higher-risk borrowers may only qualify for secured loans, which require you to offer the lender some form of collateral. If you default on the loan, the lender will keep your collateral, costing you a major asset.
Personal loans carry other disadvantages relative to credit cards, including:
- They are more difficult to qualify for, as you will need a strong credit score and an extended credit history
- Personal loans available to borrowers with bad credit or little credit history usually carry very high interest rates
- Because loan terms are fixed, you may end up paying more in interest over the lifetime of the debt than you would if you used a credit card
The bottom line: sometimes personal loans are better, while at other times, credit cards are a less expensive option. You will need to evaluate your situation to determine which choice is better for you.
Calculate Your Costs
The most accurate way to figure out whether to get a credit card or a personal loan is to calculate the lifetime borrowing costs associated with each option. To do this, use a specialized online calculator tool. Plug your numbers into a credit card debt calculator, then do the same with a personal loan calculator. After taking your income situation and overall financial stability into account, make your decision based on which of the two options will cost you less money over time.