Both credit cards and personal loans can help you secure the funds you need to make important purchases, but sometimes one is better than the other. By understanding the differences in terms, rates, repayment, and other factors, you can choose the right lending option for your situation.
Life is full of the unexpected, and that includes personal finance. While some emergency costs can be covered with a regular paycheck or by dipping into savings, others aren’t so easy to manage. When that’s the case, consumers are often faced with choosing between two primary options to help bridge the funding gap: personal loans or credit cards.
A personal loan is a lump sum of money you receive from financial institutions such as banks, credit unions, and online lenders. The loan is repaid over a predetermined period via fixed monthly payments based on the total loan amount plus interest.
A credit card, on the other hand, gives the account holder access to a revolving line of credit. The cardholder can use the card as they see fit as long as their purchases do not exceed a predetermined credit limit. Cardholders are only responsible for repaying the amount they use plus any interest accrued. Payments, which are typically made monthly, can vary based on monthly balance, interest rate, and the card issuer.
In this comparison:
- Personal Loan vs. Credit Card: Similarities and Differences
- Situations Where a Personal Loan Makes Sense
- Situations Where a Credit Card Makes Sense
Personal Loan vs. Credit Card: Similarities and Differences
Both credit cards and personal loans can be used to cover a variety of expenses, including home improvements, vacations, medical bills, debt consolidation, and more. However, there are significant differences between the two financial products, the nature of which may make one better suited for your needs depending on the situation.
A personal loan can give you access to a lump sum of money that is typically deposited directly into your bank account. A credit card, on the other hand, is considered revolving credit, and though you may have a spending limit, you can access any available credit for as long as the account remains open.
In most cases, credit cards are unsecured, although secured options are available. Unsecured means you do not need to put up collateral (e.g., car, home, other types of property) to mitigate your risk to the card issuer. Today’s personal loan market is rife with unsecured loans; however, secured personal loans do exist and are an option for borrowers with poor credit.
Interest rates are one of the primary differences between personal loans and credit cards. On average, credit card users can expect higher interest rates, with average APRs around 17.65%. Consumers with excellent credit may be able to secure lower rates while borrowers with below-average credit can expect rates in excess of 20%.
Personal loan rates, on the other hand, usually have a much broader range, with many lenders offering APRs as low as 5.99%. According to recent industry estimates, borrowers with good to excellent credit usually have access to rates between 9.8% and 15%; individuals with average to poor credit are typically assigned rates from 21.3% to 28.2%, although rates can extend well into the thirties.
Personal loans typically come with lower rates, but it is worth noting that select credit cards offer 0% APR as an introductory bonus to certain customers for a specified time period. As such, this is something that should be considered as you compare the two.
Personal loans and credit cards share some similarities when it comes to eligibility. Both types of credit products take into account your credit score, credit history, income, and existing debt load. Personal loans may require you to provide specific types of documentation, like a government-issued ID or proof of income such as a tax return or copies of your paystubs.
Some lenders, like credit unions, make highly individualized decisions when it comes to personal loan approvals, which means they may evaluate an applicant’s entire financial situation as opposed to specific scores or income levels. Credit cards approvals, on the other hand, are usually based on very specific metrics set by the company.
How Interest is Charged
Personal loans typically charge interest based on the loan’s daily balance. However, many personal loans are often amortized, which means you will have a fixed monthly payment, a portion of which goes to accrued interest and the rest to the principal balance. Over time, interest charges decrease alongside the principal balance.
Interest for a credit card, on the other hand, is only charged if you carry a balance past a single billing cycle. For example, if you spend $500 in one month and pay off the balance in full by the due date, you will not be charged interest. If you pay less than your statement balance, finance charges will appear on your next billing statement.
How credit card companies determine finance charges vary; some may charge interest based on average daily balance and others may charge interest on the ending balance.
Both personal loans and credit cards require monthly payments. However, personal loan payments are usually fixed for a specific period of time, and borrowers are well aware of their payment responsibilities at the time the installment loan is issued.
When you use a credit card, you will be required to make minimum monthly payments as long as there is a balance on the card. Required minimum payments may vary based on your credit utilization and interest rate. Both personal loans and credit cards usually offer some kind of grace period when it comes to payment due dates.
Fees associated with credit cards may include annual fees, late payment fees, returned payment fees, balance transfer or cash advance fees, and foreign transaction fees. Not all credit card issuers charge all of these fees, so be sure to read the terms and conditions before applying.
A personal loan, on the other hand, may be subject to what’s known as an origination fee. Such fees typically range between 0% and 6% of the total loan amount, which is either deducted from your loan proceeds or built into your fixed monthly payment. Some personal loans also come with prepayment penalties for paying off your loan early; late payment fees may also apply.
Ask the Expert
SVP of Lending Products and Operations at Peerform
Taking out a personal loan and paying back on a timely basis can help a consumer build good credit score as the lender reports monthly payment activity to credit bureaus. A loan is repaid over a fixed number of periods, plus interest at a fixed rate. Whereas most credit cards are revolving lines of credit up to a predetermined total credit limit amount and a variable APR, so the borrowing cost could increase if the prime rate increases. Unlike a loan, where the funds from the loan proceeds are distributed in lump sum, credit card users only draw down what they need up to the credit limit amount.
A consumer has an option to payback the entire borrowed amount or a minimum monthly payment due. A consumer paying only a minimum monthly payment due will end up paying a substantially higher amount to pay back the borrowed amount. To build credit: (1) Always pay back on time, and (2) Pay more than the minimum amount required.
When a consumer uses a personal loan to pay off credit cards, the loan has a fixed term with a fixed interest rate to pay back. While balance transfer card may be appealing due to “teaser” rate, the interest rate will like to increase substantially when the promotional period ends. The loan is a cost-effective way to pay off multiple credit cards to reduce paying higher interest amount. One disadvantage may be higher monthly payment amount depending on the term consumer decides to pay off the loan.
Situations Where a Personal Loan Makes Sense
A personal loan may make more sense than a credit card when you need the funds to make a single, one-time purchase, such as paying for a vacation, making home improvements, or consolidating high-interest debt.
>> Read More: LendEDU’s Best Personal Loans
Other situations include:
- You have a considerable amount of high-interest revolving debt and think you can secure a personal loan with a lower rate than what you’d find with a credit card. Many consumers often use personal loans to pay off credit card debt.
- You need to extend repayment over a longer period of time.
- You need a structured loan term with a fixed monthly payment and definitive end date for easier budgeting.
Situations Where a Credit Card Makes Sense
Credit cards can be the better option for some borrowers, especially when you qualify for a 0% introductory interest rate and can pay your balance in full before the promotional period ends.
>> Read More: LendEDU’s Best Credit Cards
Other situations include:
- You want to consolidate debt and have access to a 0% balance transfer credit card offer.
- You need access to a revolving line of credit in order to make small or ongoing purchases.
- You’re using a rewards credit card to rack up points for travel or other perks.
There are many similarities between personal loans and credit cards. Both can help you manage your financial needs, and because approval is largely based on your credit report, some borrowers may enjoy a low interest rate. However, there are some significant differences that may make one more favorable than the other depending on your situation.
Personal loans often carry lower interest rates may be a better option if you need to make a larger, one-time purchase you’d like to pay for over time. On the other hand, credit cards offer a revolving line of credit you can access at your discretion. If you have good credit, you may even be able to secure a 0% introductory financing offer, making a credit card more cost-effective than a personal loan in the long run.
Author: Jennifer Lobb
Join the LendEDU Newsletter
News, insights, & tips once a weekThanks for submittingPlease Enter a valid email
Personal Loans Information
Personal Loan Reviews