Credit Cards vs. Personal Loans
Both credit cards and personal loans are popular financial tools to borrow money. They can be used for similar types of purchases, but each has scenarios that are best suited to one or the other. Learn about the pros and cons of each so you can save money on interest and prevent debt from accumulating and lingering.
A personal loan can offer low interest rates for people with good to great credit, they can be for smaller loan amounts, and they can be used to pay for a range of life’s expenses, including consolidating debt, covering an unexpected expense, or making home improvements. Some lenders may restrict what the money can be used for; others won’t.
Personal loans are typically unsecured and aren’t backed by collateral that the lender can use to repay the loan if the borrower defaults on payments. If a lender offers secured personal loans, they will usually use the borrower’s savings account, CD, or share certificate as collateral.
A personal loan is an installment loan where a fixed amount of money is paid back, with a fixed interest rate, in monthly installments over the life of the loan. This period can be anywhere from 12 to 84 months. As with other loans, selecting a longer repayment period lowers the monthly loan payment, but it also means paying more money overall in interest.
Loan amounts range from $1,000 to as high as $50,000. Interest rates vary from 5% to 36%. Both the loan amount and its interest rate will depend on the lender and the borrower’s determined creditworthiness.
Most lenders charge a one-time fee, called an “origination fee” to cover their cost of processing the loan. This fee ranges from 1% to 6% of the loan amount. Usually this fee is included in the advertised APR of the loan. Some lenders also charge a prepayment penalty if the loan is paid off early. It’s sometimes included in the interest fee (often under the term “pre-computed interest”). If possible, it’s best to avoid taking out a loan with this kind of charge as part of the loan terms.
The application process for a personal loan is similar to other loans. The lender will make a hard inquiry on your credit report. They will consider your income, total debt, and credit score to determine your creditworthiness, which in turn will affect the amount they are willing to lend and at what rate.
Credit cards, like personal loans, are also unsecured. They offer a line of credit, a pool of available money to spend from. You “borrow” money from this line of credit by making purchases with the card and then repay that amount. Unlike a loan, as soon as you pay off part of your balance, it frees up that same amount for you to use again. You can borrow repeatedly as long as you stay below your credit limit and make on-time payments.
Credit cards are good for buying from merchants. Perks include generous buyer and fraud protection features and potential cashback or other rewards. However, in general, credit cards have higher interest rates that can increase (on future purchases made on the card or if a payment is made 60 days past due), and it can take up to 30 years to pay off the balance if only minimum payments are made each month. Credit cards can also entice users to live beyond their means.
Credit cards vs. personal loans
With all of that in mind, personal loans are best for:
- Larger, planned financial needs that allow for a longer repayment period
- A set repayment schedule and pay off date (with the option to pay the loan off faster)
- When you need cash
Credit cards are best for:
- Short-term debt you can pay off within 30 days or at least a year
- Having on hand for unexpected daily expenses