So – you’re in a bind for cash and have a major expense (or a few) on the horizon. You’ve researched financial products that can get you the money you need, but you’re still unsure of which one is right for you.
For many people in similar situations, the decision comes down to credit cards vs. personal loans. While they may seem like interchangeable payment methods, there are pros and cons to each that you should be aware of before moving forward.
To help you make an informed decision, we’re going to take a closer look at personal loans and credit cards, the advantages and disadvantages of each, and when it’s more appropriate to use one product over the other.
What is a personal loan?
A personal loan is a sum of money you borrow from a lender and pay back in fixed monthly payments over a set period of time. They can be used to consolidate debt, pay for emergency expenses, make improvements to your home, or practically anything else you can think of.
How do personal loans work?
Personal loans are a form of installment credit, just like auto, mortgage, and student loans. As such, they work in a similar manner – you apply for the amount you want, and the lender uses your financial history, credit reports, and credit scores to determine if you qualify and at what interest rate.
Generally, the higher your credit score, the lower the interest rates you’ll qualify for – and these lower rates can save you a lot of money in the long run. So, if you’re thinking about applying for a personal loan, it’s wise to get that score up before submitting your application.
Start raising your credit score now with the help of our resource “6 Tips for Building Your Credit”.
If you’re approved, you’ll repay the loan in monthly installments until it’s completely paid off. Once it’s repaid in full, the account is closed.
There are two types of personal loans: unsecured and secured. We’ll briefly cover the differences here, but if you’d like a more in-depth look, check out our article Secured vs. Unsecured Personal Loans for the full scoop.
Secured personal loans are backed by collateral, a valuable asset like the borrower’s home or car. When one accepts a secured loan, they may agree to give up these assets if they can’t repay according to the terms. If a borrower’s unable to repay their loan, lenders could take possession of these assets and sell them to try to recoup their losses.
With an unsecured loan, collateral is not required. But, similar to a secured loan, information from the borrower’s application, credit reports, and credit scores could all play a role in whether or not they get approved. For more information on all things personal loan, take a look at Personal Loans 101: What You Need to Know.
Advantages of Personal Loans
One of the main benefits of personal loans is that they allow you to roll several bills into a single monthly payment, remarkably simplifying your financial life. With that said, there are a number of additional advantages personal loans have to offer.
Monthly payments stay the same: With a fixed-rate personal loan, your payment stays the same every month. This allows you to budget for the expense ahead of time and know exactly when it’ll be paid in full.
Interest rates are typically lower than credit cards: The rates you receive ultimately depend on your credit score and financial history, but on average, personal loan interest rates are significantly lower than credit card interest rates.
Apply for exactly what you need: Whether it’s $2,500 or $25,000, an advantage personal loans have over credit cards is that you can apply for the exact amount of money you need. This can be especially beneficial for those who tend to overspend because unlike credit cards, once the loan is spent – it’s spent.
Quick approval: When you apply for a personal loan, you’ll typically receive a decision within 1-3 days. If you’re approved, in some cases, money could be deposited in your bank account in the same timeframe.
Use it for pretty much anything: As we mentioned, personal loans can be used in a variety of ways to suit your needs. For a full list of possible uses, visit our Personal Loans page.
Disadvantages of Personal Loans
Can increase debt if managed improperly: Keep in mind, using a personal loan for debt consolidation doesn’t mean your debt’s disappeared – it’s just moved around a bit. If you pay off credit card debt with your loan and start swiping your card for major expenses again, you could quickly be in more debt than you were before you secured the loan.
Lump-sum payment: When you take out a personal loan, a one-time lump sum payment is deposited into your bank account. If you realize you need additional funds after accepting the loan, you won’t be able to take out more money (like you can with a credit card.)
How do credit cards work?
Most of us are familiar with credit cards and how they work, but we’ll cover a few basics here for a quick review.
In addition to making purchases, many credit cards can be used to transfer balances and get cash advances. They’re considered a form of revolving credit, which means when you pay your balance off, the line of credit renews up to the credit limit.
In other words, you can continue drawing funds from your credit card until you reach your credit limit. When you pay down your balance, you’ll be able to spend again. Remember, personal loans are different – once your loan is used up, you won’t be able to borrow more money (unless you apply for another loan.)
Advantages of Credit Cards
Credit cards offer different benefits depending on how you use them and how often you use them. In general, advantages of credit cards include building your credit, receiving rewards, and fraud protection – but that’s not all.
Convenience: No need to search for an ATM or worry about not having enough money on hand – your access to funds is tucked neatly inside your wallet. Plus, if you already have a credit card with funds available, you can borrow right away with no need to complete an application.
Intro deals: Some credit cards have introductory APRs of 0% for a set amount of time, usually a period of 6-12 months. During this period, you won’t incur any interest charges for carrying a balance. And, if you pay off your balance before the promotional period ends, you’ll avoid paying any interest whatsoever. With that said, most into APRs apply only to purchases – cash advances are typically excluded from promotions.
Disadvantages of credit cards
Easy to overspend: Research has shown that people are willing to spend more when paying with a credit card instead of cash – as much as 83% more in some cases. It can be extremely easy to overestimate your purchasing power while using a credit card, so keep a close eye on your usage to avoid unnecessary debt.
High-interest rates and hidden fees: When applying for a new credit card, be sure to read the fine print – especially the list of fees and the APRs that apply after the promotional offer ends.
Can quickly damage your credit: How quick? Really quick. One late payment can lead to a 90 – 110-point drop in your credit score, even if you’ve had a perfect financial history up until that point. It’s crucial that you manage your credit cards responsibly to save yourself from negatively impacting your credit.
For information on how to avoid common pitfalls and use your card wisely, take a look at our resource “Best and Worst Ways to Use Credit Cards”.
What’s the better choice? Personal loans or credit cards?
So, what financial product should you consider moving forward with? That depends on a few things: how much you need to borrow, how quickly you plan to pay off the debt, and how good your credit is.
When’s it better to use a credit card?
As a rule of thumb, credit cards are a better choice for short-term expenses and smaller purchases you can comfortably repay within a year. Why?
When compared to personal loans, credit cards typically have much higher interest rates. The longer you take to pay a balance in full, the more interest you’ll be charged – and it can get costly, fast. That’s why making more than your minimum payment every month is a highly recommended financial move.
With that said, if your credit is good enough to qualify for 0% introductory APR, and you pay off your balance before the promotion ends, you can save a lot of money by moving forward with a credit card over a personal loan.
When’s it better to use a personal loan?
In general, personal loans are better suited for long-term, larger expenses that will take you more than a year to repay, like home improvements, credit card refinancing, major debt consolidation, and expensive auto repairs.
If you’ve been known to overspend, you may find that a personal loan is a better option for you. The convenience credit cards provide is a double-edged sword – if you’re unable to resist the temptation to use them frequently, you could get stuck in a cycle of debt that’s difficult to escape from.
As is the case with most financial matters, there is no one-size-fits-all answer to this debate – but hopefully, what we’ve shared here has made your decision a bit easier. For more relevant information on personal loans and credit cards, take a look at a few of the resources we’ve linked below.