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Personal Loan vs. Credit Card: Which Is Better?
When you need cash, personal loans or credit cards are two ways to get quick financing. But either option can affect your credit score, and there are pros and cons to credit cards vs. loans, depending on how much money you need and when you’re able to pay back what you owe.
Use this guide to credit cards vs. personal loans to understand which option is better depending on your situation.
What is a personal loan?
A personal loan is a lump sum amount of money provided to you by a bank or credit union. You’ll pay interest on the loan and will typically make payments back in monthly installments.
Personal loan terms generally last at least a couple of years and may last up to a decade. They can also be secured with collateral, like a home, or unsecured, requiring no collateral at all.
To get a personal loan, you’ll sign a terms agreement covering what payments you’re expected to make and when, plus late fees and other terms. If you don’t abide by the terms or you fail to make your personal loan payment, you’ll incur fines and a hit to your credit score.
[ Read: Loan Lender Reviews for 2020 ]
What is a credit card?
A credit card is a form of payment where you use a line of credit to pay for items in person, online or over the phone. You can apply for a credit card for free with a bank or credit card company.
There are both unsecured and secured credit cards. With secured credit cards, you’ll need to make a cash refundable deposit, the amount of which will become your line of credit (the amount of money you can charge to the card). With unsecured credit cards, there’s no deposit requirement.
Credit cards require a minimum monthly payment on the balance you’ve charged. Whatever you don’t pay in full will be charged interest and carry over into the next month’s balance. This creates a revolving balance, where your balance will depend on what you haven’t paid off each month.
The line of credit for a credit card is the maximum amount you’re allowed to have outstanding in unpaid charges. Failing to pay the minimum amount due will result in potential fees and a negative impact to your credit score.
Credit card vs. personal loan
While a personal loan is a single lump sum with a specific repayment schedule, a credit card can be used for multiple purchases over an indefinite amount of time.
The interest rates you’ll get for both a credit card and a personal loan will depend on factors like your credit score. Credit cards typically have a higher interest rate on charges than personal loans do. However, credit cards may also offer rewards like cash back or travel points for using them, while personal loans don’t typically offer rewards for borrowing money.
When to use a personal loan
When should you use a personal loan? There are a few scenarios where it might be beneficial.
One is when you have a high amount of credit card debt and you want to consolidate that debt. Because personal loans typically have a lower interest rate, you could get a lump sum from personal loans to pay card debt off. Then, you can make lower overall payments to the personal loan, saving you money over the long term.
Another reason to use a personal loan is when you need a large sum of money and you need longer to pay it off. For example, if you want to spend tens of thousands of dollars on home improvements to increase the value of your home, a personal loan might make sense. Credit card credit limits may not be as high as you need them to be for expenses like these. You can pay off debt on a manageable schedule without incurring high fees for debt accumulation.
[ Read: Best Home Improvement Loans for 2020 ]
Pros of a personal loan
- Lower interest rates than credit cards
- Large sum of money can be borrowed
- Predictable payment plan
- Positively impact a credit score with on-time payments
Cons of a personal loan
- Locked into specific loan payments
- Don’t get to charge more money each month
- You must pay interest, even with on-time payments
When to use a credit card
When should you use a credit card? Credit cards can be instrumental in building up a credit score, which is a significant factor if you want to take out a loan like a mortgage.
Credit cards can also help you earn free rewards and cash back just by using them. As long as you’re able to pay off the balance in full each month, you can use credit cards for everyday spending and never pay extra on interest.
It’s best to treat credit cards like cash. Ideally, you’d only spend what you’re able to pay off each billing period to avoid late fees and accrued interest.
There are also some credit cards that provide a 0% annual percentage rate (APR) period for a year or more. You could use one of those if you’re able to pay off the card in full by the time the intro 0% APR ends.
[ Read: Best Rewards Credit Cards ]
Pros of a credit card
- Earn potential rewards and cash back for transactions
- Charge whenever you need to
- Build a credit score with responsible use
- No interest when charges are paid in full
Cons of a credit card
- Higher interest rates than personal loans
- Access to immediate money can lead to overspending and debt accumulation
- Spending limits may be too low for what you need
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