Which is better: a personal loan or a credit card?
Probably, two of the most common ways of borrowing are personal loans and credit cards. Even though both hold the potential to be very useful financial tools in many different ways, each comes with a different set of advantages and disadvantages. Knowing the key differences of how a personal loan works versus a credit card is important for you to make a choice. Let’s break down the key factors to consider.
1. Interest Rates
Personal Loan:
Most personal loans have comparably lower interest rates compared to credit cards, especially in a case where a person has good credit. The interest rates on personal loans are usually fixed. The implication here is that they remain the same throughout the complete term of the loan. This has the advantage of helping make personal loans a cost-effective way to borrow larger amounts or to consolidate other, higher interest debt.
Credit Card:
Generally, credit cards charge higher interest as compared to personal loans, especially if you happen to be an average or bad credit borrower. On the other hand, credit cards can avail the advantage of a revolving line of credit—meaning you won’t be charged interest on the outstanding amount if you don’t pay off the principal in full each month. Some of them come with promotional 0% APR periods that can be very rewarding to clear off short-term borrowing if you can manage to clear the balance before the promotional period goes away.
Winner: Since personal loans mostly have lower interest rates, they are more suitable for large, long-term borrowing.
2. Repayment Terms
Personal Loan:
Personal loans have fixed repayment terms. Such methods run from 12-60 months. You will be required to pay a fixed amount per month to the principal plus interest, which will help you in repaying your loan by a particular date. This structure makes your repayments quite predictable and on time.
Credit Card:
Credit cards do not have a fixed repayment term. Although you are required to make a minimum payment every month, you can theoretically carry a balance forever if you continue making payments. This permits flexibility, but the minimum payments may keep you in debt for a long time since the interest will continue accumulating.
Winner: While personal loans provide more structured repayment, it’s best if you prefer the clear path to being debt-free.
3. Flexibility in Borrowing
Personal Loan:
A personal loan gives you a lump sum upfront, which you then pay back over time. They’re great for large, one-time expenses: things like renovating your home or medical bills. Even debt consolidation works well with personal loans. You cannot draw on it again after the loan has been taken out without applying for a new loan.
Credit Card:
A credit card gives revolving credit, allowing one to draw upon the credit limit at will. This makes them more flexible for ongoing or variable expenses. You can continue to borrow and repay while remaining within the limit, which may come in handy when the expense is small in amount or of casual nature.
Winner: A credit card is more flexible and hence better for running or small expenses.
4. Fees and Charges
Personal Loan:
Yes, some personal loans do come with fees, but as an origination fee, these are usually taken from your loan money. However, once you have acquired your loan, you typically just need to deal with your monthly payment. There aren’t typically ongoing fees unless you either miss a payment—or pay off your loan early and take a prepayment penalty.
Credit Card:
Some of the fees charged with credit cards include an annual fee, late payment fee, balance transfer fee, and foreign transaction fee. If you do not pay off your full balance in a month, you’ll be charged interest. But some credit cards have features like rewards or cash back that might help offset some or all the fees.
Winner: Personal loans generally charge fewer ongoing fees, so this is much more of a no-brainer where the costs involved are predictable.
5. Impact on Credit Score
Personal Loan:
Provided the payments are made on time, personal loans can have a positive effect by adding installment credit to your credit mix. Applying for credit which is convenient and quick would result in a hard inquiry and thus bring down your credit score.
Credit Card:
Used well, credit cards can actually help raise your credit rating. Many of the factors that contribute to a good credit score are keeping your credit utilization low and making on-time payments. Large balances or missed payments will bring your score down.
Winner:
Both personal loans and credit cards can either positively or negatively affect your credit score, depending on how you use them.