If you ever find yourself in a position where you need money to cover some expense, you will always be confronted with two options; whether to take a personal loan or to use up the limit on your credit card.
However, within these two options, there are many things you should consider to make the best decision.
Whether it is a personal loan or a credit card, they can both give you access to quick cash. However, there are pros and cons to each method.
So, before deriving a conclusion about whether credit cards are better than personal loans, let us dive deep into everything that you should know about each of them.
What Is a Personal Loan?
Most people are familiar with credit cards because they use them frequently. However, a personal loan is much too peculiar and unfamiliar.
When taking out a personal loan, there are often certain conditions attached. One of these conditions is that personal loans are often for very specific purposes.
For example, some of these conditions may be debt consolidation, student loan, home improvements, emergency expenses, and anything that your lender has written down in their terms and conditions section. A personal loan can be taken from various institutions like a bank, a credit union, or an online lender—more here on this issue.
A personal loan is very similar to other kinds of loans, such as a mortgage or a car loan. You simply have to apply for a loan, the lending institution goes over your credit report, your income, financial statements, and comes up with a loan offer.
Traditionally, the better your credit score is the better the loan rate you’ll receive. This means a lower interest rate and maybe a lower monthly payment. Once you sign onto the loan, you will pay back the amount in either monthly, bimonthly, or quarterly installments (depending on your agreement).
You may find that personal loans are not strict in their compliance. For example, for some lenders, you may not have to show your credit report at all. These are usually smaller loans with higher interest rates. However, for other types, you may have to give an asset as collateral.
So, a car title loan is usually when you take a loan out and the lender uses your car as security or collateral. Such loans are short-term and, again, have higher interest rates. These loans also tend to be informal, so there may be no bank involved.
What Is a Credit Card?
A credit card is essentially a card that a bank or credit card company issues to you. This card then becomes a form of payment that uses your line of credit to let you make purchases. These purchases are often for items that you buy in person or online. You simply have to use your credit card number to make purchases.
Credit cards come in two different types. You can either get an unsecured card or a secured card. In the matter of unsecured cards, you will not have to make any cash deposits to the credit card company.
However, it will be compulsory for you to return an amount to the credit card company at the end of every month in the secured card matter. The amount that you deposit will directly contribute to your line of credit. This will then determine how much money you can charge onto the card.
Similarly, most credit cards only require the minimum amount of payment on the balance you’ve changed, that is to say, the amount of money you’ve spent through the card.
Thus, essentially your balance (the amount you can make purchases through) will depend on the amount you’ve given back. And this changes each month depending on what you return.
The maximum amount that you can have as an outstanding balance will become your line of credit. Thus, if you fail to pay at least the minimum amount required, you may get charged a fee which will negatively affect your credit score.
Credit Card vs. Personal Loan
So, before we dive into the pros and cons of credit cards and personal loans, let’s look at the general rule of thumb for both options.
- Personal loans are mostly taken out for large amounts of money, usually to buy a house, a car, or start a business. These loans will also probably take much longer to pay off, but they have lower interest rates.
- On the other hand, credit cards are usually used for shorter day-to-day expenses, such as groceries and car repairs. This is because these loans can be paid off very easily and quickly and also because credit cards usually have higher interest rates than most people wouldn’t want to prolong.
Now, let’s look at some of the pros and cons of each option.
Pros and Cons of Personal Loans
- Personal loans generally have lower interest rates compared to credit cards. However, the interest rate will depend on your credit score.
- Personal loans are not overly tempting. This is to say that you will most likely not borrow money as frequently as you would when you’re using a credit card.
- You will be able to know when you will be done with your debt, unlike credit cards, where you tend to get stuck in a debt cycle.
- Personal loans allow you to build a better credit score as long as you’re making timely payments.
- Interestingly, if you use a personal loan as payment for your credit card debt, you will be able to lower your credit utilization ratio. This means the percentage of credit you have used up will go down. This is also a way to take up your credit score. However, this is only when you are not using your credit card.
- Personal loans are mostly taken at a fixed interest rate. So, you will be paying the same amount of money throughout your agreed term unless there are late payments or a dramatic change of some sort.
- Since a personal loan is usually a large sum of money, there are often large payments required. So, unlike in credit card payments, the minimum here will be a much larger sum of money. This tends to be a problem for many people who survive off of a smaller disposable income.
- Depending on your contract and the lender, there can be odd fees attached to your personal loans. These could include an upfront fee or a prepayment penalty.
Pros and Cons of Credit Cards
- Credit cards provide you with very easy access to extra money.
- A lot of new companies offer 0% introductory rates for new users. This means if you pay your dues on time, you may not have to pay the interest on the amount at all.
- You can get a credit card even if your credit score is not doing very well, which is rarely possible in personal loans.
- However, unlike personal loans, the interest on credit cards can change. This means your interest rate can drive up the total amount of money you owe to the company. This can increase debt immensely.
- You can seldom take out a cash loan from your credit card. For this, you’ll have to pay an additional fee in advance.
- Lastly, since the card is at hand always, it is highly tempting to use it and make purchases.
Personal Loan or Credit Card: Which Is Better?
Well, this question never has an easy answer. In fact, you may have to ask yourself some very tough questions first to be able to assess the main question.
For example, if you think you need to borrow a small amount of money, then credit cards are a good option.
However, if you think you may take longer to pay the amount off, then a personal loan may be better, given that it comes with lower interest rates.
The question also depends on how good is your credit score. If it is good, then you may be able to score a low-interest deal on a personal loan. However, if it is bad, then the credit card is your only option. In fact, you also need to determine whether you need cash or not. If you do, then the personal loan is your best friend.
Similar questions like whether you have a tendency to overspend or you’re an easily tempted person. If so, you should never go for a credit card because it can trap you in a serious debt cycle.
However, these are important questions to ask if you want to remain cognizant of how much you spend and how you want your future spending to look like. So, no option is better or worse than the other. It all depends on what conditions you’re taking the loan under.