Personal loan vs. credit card: What's the best choice?

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Maybe you want to fund a home renovation or consolidate high-interest debts. Personal loans and credit cards are both convenient ways to borrow money, but they have their differences.

Personal loans are often a good choice when you need to borrow a large sum of money, or you want to consolidate debt. Credit cards may be better for smaller purchases or managing daily expenses.

Deciding between a personal loan and a credit card is ultimately up to you and your financial needs. Here’s how to decide between the two.

What’s the difference between a personal loan and a credit card?

When you should use a personal loan

A personal loan lets you borrow a lump sum of money and pay it back over a set period of time. These loans have fixed interest rates and a set monthly payment, making them easier to budget.

Personal loans are typically unsecured, meaning there’s no collateral, and you can use the funds however you want. This is different from a mortgage, where your home is used as collateral if you don’t make payments.

Jeff Rose, certified financial planner and founder of Good Financial Cents, outlines a few scenarios where personal loans may be more beneficial than relying on a credit card.

• Debt consolidation: A personal loan can help you merge multiple high-interest debts into a single payment. Personal loans often have lower interest rates than credit cards, which can save you money in interest.
• Large purchases: When you take out a personal loan, you’ll receive a lump sum, making it easier to finance a big purchase like a vacation or home makeover.

"While (personal loans) are helpful for big one-time costs, they're not a one-size-fits-all solution, and taking on a large debt requires careful consideration," Rose says.

Pros and cons of personal loans

When you should use a credit card

Credit cards offer an unsecured revolving line of credit, allowing you to make purchases up to your credit limit and pay them off over time.

You’ll get a physical credit card to buy things or pay bills online and in person. Because of this, credit cards are often more convenient to use for daily expenses than a personal loan.

Credit cards are handy for things like spontaneous online shopping, sudden car repairs, or even booking a quick trip, Rose says. Other situations include:

• Buy now, pay later: Credit cards’ flexibility can make managing unexpected expenses or variable cash flow easier.
• Earning rewards: Many credit cards offer cash back or travel rewards on your spending, which can be a major perk. 

Credit cards also come with an introductory 0% APR period, which lasts from 6-21 months. This means you can consolidate your debts onto one card and pay no interest for a set period of time.

But remember that the high interest rates on credit cards can sneak up on you. Credit cards work best for those who use them for convenience and rewards without carrying a balance from one month to the next, says Robert Farrington, CEO of The College Investor.

"I strongly believe you should treat your credit card like a debit card and only charge what you can pay off each month," Farrington says.

Pros and cons of credit cards

Should you use a personal loan or a credit card to consolidate debt?

While personal loans don't offer rewards or 0% APR offers, they offer something credit cards don’t — predictability.

When you take out a personal loan, you know exactly what your monthly payment will be over the course of the loan. This can help you budget and manage your payments better.

Because personal loans often have lower interest rates than credit cards, you may save money in interest.

If you have a smaller amount of debt, you can use a balance transfer credit card offering an introductory 0% APR period. But you’ll want to have a plan to become debt-free before that introductory period ends.

Say you have $5,000 in credit card debt and pick a card with 0% APR on balance transfers for 18 months. Can you make a minimum monthly payment of $278 to pay off your debt before the introductory period is over?

Also, make sure you’re factoring in balance transfer fees, typically 3%-5% of the total transfer amount.

The bottom line

The choice between a personal loan or a credit card depends on what you’re looking for. You'll have to consider which option works best for you both in the short and long term.

For the most part, credit cards are best for short-term borrowing, and personal loans are better for those who need to borrow for the long haul.

Editorial disclaimer: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.