In a perfect world, you’d have the cash to cover any expenses that come your way.
But because this isn’t the case for everyone, you might look into personal loans and credit cards to pay for them. Both options can help you out, but you may wonder when to use one over the other. Below, we’ll dive deep into personal loans vs. credit cards so you can make the most informed decisions for your unique spending habits and situation.
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The main difference between credit cards and personal loans relates to how you receive the funds. Credit cards offer a revolving line of credit you can withdraw funds from whenever you’d like, up to your credit limit, which is based on your credit and other factors.
Personal loans, on the other hand, are considered installment loans that provide a lump sum upfront. Once you spend your loan funds, you must apply for another personal loan to access more money.
With a credit card, you have the option to make a minimum payment every month. You can also repay your balance in full and avoid variable interest charges, which fluctuate based on market factors. When you take out a personal loan, you’ll make fixed payments for a predetermined term, which often ranges from two to seven years. You’ll know exactly when you’ll pay it off.
Credit cards may come with annual fees, foreign transaction fees, and late payment fees, and many personal loans charge origination fees and late payment fees. Several credit cards and personal loans advertise minimal to no fees.
Personal loan | Credit card | |
Best for | Large one-time purchases | Everyday spending |
Type of financing | Installment loans offering a lump sum of money you repay over time | Revolving credit, meaning you can borrow money as needed up to a set limit |
Interest rates | Fixed interest rate for the life of the loan | Variable interest rate on any unpaid balance |
Repayment terms | Fixed payments for a predetermined term (often 2 – 7 years) | Revolving payments with a minimum due each month |
Fees | Origination & late payment fees | Annual & late payment fees |
In certain situations, personal loans make more sense than credit cards. A personal loan is likely a better fit to:
Sometimes, credit cards are a smarter choice than personal loans. A credit card may be worthwhile for:
As with all financial products, personal loans and credit cards have benefits and drawbacks you should consider, including:
Pros
Lower interest rates
Compared to credit cards, personal loans often come with lower rates. This is particularly true if you have solid credit. A lower rate can save you hundreds or even thousands of dollars in interest charges.
Fixed monthly payments
Most personal loans have fixed rates and set monthly payments. You’ll know exactly how much you’ll howe every month and can budget for your payments accordingly.
Fast funding
With a personal loan, you can get a large sum quickly. Depending on the lender and when you apply, you may collect the funds that same day, within 24 hours, or in a few business days. Online lenders are known for the fastest funding.
Cons
High rates for bad credit
If you have no credit or bad credit, you may struggle to find a personal loan with a low interest rate. Many bad-credit personal loans come with high interest rates, often in the triple digits.
Potential fees
With a personal loan, you may be on the hook for fees in addition to interest charges. These could include origination fees and late payment fees. Fees will increase your overall cost of borrowing.
May need collateral
Most personal loans are unsecured, but some are secured and require collateral, such as your house, car, or savings account. If you fail to make your payments, the lender can seize your collateral. A home equity line of credit (HELOC) is an example of a secured loan that uses your home as collateral.
Here are the benefits and drawbacks of a credit card.
Pros
Flexible funding
A credit card is a revolving line of credit. You can use it to pay for purchases at any time as long as you don’t exceed your credit limit. If you use the card responsibly, you may even qualify for credit increases and have access to more funds.
Potential for interest-free purchases
As long as you pay off your credit card balance in full every month, you won’t owe interest. Interest-free purchases can save you significant money in the long run.
Access to perks
You may enjoy a 0% APR promotional period or rewards, such as cash back and travel points. Some credit cards also offer unique perks, including free credit score monitoring and financial planning.
Cons
Potentially high interest charges
You can choose to make the minimum monthly payment, repay your entire balance, or anything in between. If you don’t repay your credit card balance in full every month, you’ll rack up interest charges.
Annual fees
Some credit cards charge annual fees. Depending on the card, these can range from $95 to $500 or even more. It’s smart to make sure the perks offset the annual fee before you sign up for a credit card that has one.
Risk of overspending
The convenience and ease of a credit card can make it easy to spend more than you can afford to pay back. Credit card debt may take a serious toll on your finances.
If you’re facing multiple high-interest debts, you may want to consolidate them with a personal loan or balance transfer credit card. By consolidating, you can simplify the payoff process because you only make one payment each month. You don’t need to keep track of multiple debts with different repayments and due dates. Debt consolidation may also save you money on interest charges and make it more affordable to become debt-free.
Whether this makes sense for you depends on your situation. First, check your credit score to find out where you stand. If you have fair credit or bad credit, debt consolidation through a credit card may not be an option. Balance transfer credit cards, which you can use to consolidate debt, tend only to be available to those with good-to-excellent credit.
With a shaky credit history, a personal loan might be your only choice. If you opt for a personal loan, shop around and get quotes from at least three different lenders. Many lenders will allow you to prequalify and check your offers without any impact on your credit. Compare all your offers, and choose the one with the lowest interest rate and most favorable terms. Ideally, this rate will be lower than the rates you’re paying on your other debts.
If you have strong credit and qualify for a balance transfer credit card, you’ll need to transfer all your credit card debts to the card and pay a balance transfer fee of 2% to 5% of the total transfer amount. Do the math, and make sure your potential savings outweigh the fee. If they don’t, or if most of your debt isn’t credit card debt, you may be better off consolidating with a low-interest personal loan.
Whether you’d be better off with a personal loan or credit depends on your unique circumstances. Before you decide, ask yourself why you need the funds, how much you’d like to borrow, what your credit looks like, and when you want the money. The answers to these questions can help you zero in on the right financing solution.
If you have good credit and hope to pay for a kitchen remodel, for example, shopping for the best personal loans is likely the way to go. A credit card might make more sense if you have smaller everyday expenses or hope to earn rewards. Keep in mind that personal loans and credit cards are not mutually exclusive. You can use both in different situations.
In terms of financial risk, it can depend on your personal habits and circumstances. Credit cards might bring more risk because they often have higher interest rates, and the potential for overspending can be tempting.
Personal loans can offer fixed interest rates, fixed repayment terms, and a set monthly payment, which may make them less risky.
Personal loans and credit cards can affect your credit score. Payment history, which includes your ability to make consistent on-time payments, accounts for a significant portion of your credit score. Both types of credit contribute to your payment history.
A credit card also affects your credit utilization rate, which can have a significant influence on your credit score. If you max out your credit card or use too much of your limit, it can lower your score.
Usually, you’ll pay more interest with a credit card than a personal loan. Average credit card interest rates often outpace those of personal loans. The variable nature of credit card interest rates, coupled with late payment penalties, can also increase costs over time.
However, many personal loans include origination fees. If a personal loan offers a lower rate, you could save on interest payments compared to using a credit card.
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