Depending on the reason for needing a lump sum of money upfront, there are several factors that will affect a decision about taking out a personal loan versus applying for a new credit card.
This article will detail the differences between personal loans and credit cards, the pros and cons of each, and the options for financing anything you may need in your life while on the journey to financial security.
There rarely comes a time in one’s life when it’s easy or exciting to figure out how you’re going to pay for something big like an emergency hospital visit, major home repairs, or even a major move. Learning the different options available to someone in those situations will make it a little easier to navigate.
There are a few differentiators between personal loans and credit cards. A personal loan will provide a certain amount of money (usually a larger amount) that is paid back in installments until the balance reaches zero.
Credit cards, on the other hand, provide an established credit line with a monthly balance. You will also make monthly payments on a credit card, but the amount will change each month, based on your spending habits and ability to pay it off each month.
It can be a little daunting and confusing to figure out which route is best. There are some nuances to each option, not to mention the growing number of credit card offers out there with all the various perks, rewards, and interest rates.
Below, details are shared on which situations call for a personal loan vs credit card and which one is best for any situation where some extra financial support is needed.
A 2019 Study by Experian discovered the following top reasons for taking out a personal loan in the United States:
In general, before looking at a personal loan, you should determine how much money you need, for what purpose, and how quickly you think you’ll be able to pay off the debt.
Personal loans are generally a good idea if you can find a low Annual Percentage Rate (APR). Qualifying for a low APR depends on your current credit rating and financial status.
Consolidating high-interest debts is another great reason to take out a personal loan. Getting all debt into one place and at a lower rate will help pay off the principal more quickly while also making payments more affordable.
Another common reason for taking out a personal loan is to finance a large, one-time purchase. Loans are not designed to be taken out repeatedly or many times. Some examples of these types of expenses would be home improvement projects, education and tuition fees, or even special events like a wedding or anniversary.
With any type of financial decision, there are going to be substantial pros and cons. With personal loans, the most important pro to be aware of is that they generally have lower interest rates than credit cards, meaning you will pay less interest over time.
Second, a personal loan offers fixed payments. Fixed payments are easier to track within your budget and gives you more control over expected expenses each month.
In addition to lower interest rates and fixed payments, a lot of lenders now let you prequalify for a loan to browse rates without a “hard pull” on your credit. The process can be very quick and super easy nowadays!
Lastly, personal loans have one more advantage over credit cards - they tend to be approved and move a lot quicker than credit card applications. because loans tend to move a bit quicker. There are a number of lenders now that offer fast funding and may be easier than applying for credit cards.
While a personal loan has a lot of pros, there are a few cons to be aware of as well.
Unfortunately, if someone has fair or bad credit, they may only qualify for higher APRs. This is simply a way for banks and lenders to protect their investments.
Personal loans also tend to be rather inflexible. Once the payment schedule is agreed upon, it can be difficult to make changes, either to the amount due or the due date itself.
While getting a fixed amount of money may work for your purposes, a personal loan is definitely different from a credit card. Remember: with a personal loan, there is no credit line to draw from. You get a set amount of money upfront, and this cannot be adjusted once received.
To ensure a personal loan is right for you, you should review the monthly payment structure to be sure the payments can be made over the full term of the loan. If you get behind on loan payments, this can negatively affect your credit score, so you’ll want to make sure you are ready to make the regular payments on time and in full each month.
Installment loans are the most common type of personal loan. These loans give you all the money at once and then you make regular payments over a set period known as the “term of the loan”.
The term of the loan can vary, depending on the payment structure that will be agreed upon by you and the lender. It can be anywhere from two to seven years and largely depends on the sum of money being borrowed plus the borrower's comfort level with payments.
The amount of a personal installment loan will be highly dependent on the borrower’s income and ability to repay. In addition to that, all states impose regulations on how much can be borrowed.
If the reasons for getting a loan mentioned above don’t jive with your current situation, it may be time to look at a credit card to finance purchases.
Credit cards are useful for smaller expenses: things like groceries, monthly bills, and gasoline are all ideal, small expenses that work on a credit card. In general, most people use credit cards for their day-to-day spending.
The reason smaller expenses are recommended for credit cards is because of their higher interest rates. It’s important to note that the balance on a credit card should be paid off in full each month, otherwise interest will begin to accrue, and this can negatively affect your credit rating as well.
In some cases, credit cards are used for emergencies, such as car repair, appliance replacements in a home, emergency health services. Depending on the amount of the purchase, this can be a good option if an interest-free purchase is needed in a bind.
Have you heard the term “hard credit pull” before? This happens any time someone applies for credit, a credit card.
When a credit pull happens, it can cause a short-lived drop in your credit rating. Personal loan options, for the most part, affect this score less than when applying for a credit card. This is another added benefit of choosing a personal loan, if the other criteria are met and you qualify for a personal loan.
The major reason this happens is because of the fixed payments that come with a loan. This stability creates a better situation for your credit score over a long period of time.
The credit cards will always have a balance though. And you get to choose if you want to pay it off or let it accrue interest. Showing creditors that you pay on time is a good show of being worthy of credit - and this difference has a bigger impact on your credit score in the short term.
Before choosing which options are available to you for debt consolidation, it’s important to make the decision to reduce your spending and put everything you have available into paying off the debt.
In the end, a personal loan and a credit card can provide the funds you need in the short term to help gain some relief from debt payments.
In some cases, a borrower may already be paying off high-interest debt. If that’s the case, a personal loan may be the best option. This will get the borrower switched to a lower interest rate, while also making monthly payments more affordable than what exists with the credit card payment plan.
While the personal loan rate will offer lower rates, there are some cases that a credit card may have a promotional offer with very low-interest rates. Seek out this option if the amount of your debt is less than $5,000 and you are confident you can pay the amount off over the term of the offer (usually 12-18 months)
There are so many options for applying for credit these days! With technology ever-expanding, most offers can be found online. Be sure to do some research to find a trusted bank or lender that will help you get the funds you need.
Before beginning the application process online, or in person, you will need to be able to answer the following questions:
Once you’re able to answer these questions, you will be better prepared to talk to a lender or apply online.
If the application process is happening online, you can rest assured that it will move quickly. Most lenders have automated systems that work directly with credit-checking agencies. In some cases, you may even have the determination within minutes!
A thorough review of the reasons for applying for credit and additional funds will help you determine the best route for getting access to those funds in the quickest manner possible.
Larger purchases and financing needs will generally require a personal loan. It’s simply a safer option for large amounts of money. Personal loans allow for fixed, monthly payments over time, and with an end date in sight, it can be less risky to make big purchases with a personal loan.
Smaller purchases are best reserved for a credit card that offers a revolving line of credit. It’s smart to keep these balances on the lower end, otherwise, the borrower will run into high-interest rates and accrue more debt if unable to pay off the balance each month.