When you need to make a purchase or pay a bill and don’t have cash on hand, there are a few options for getting the funds you need. Two of the most popular choices are a credit card or personal loan. Choosing the best option will depend on a variety of factors, and understanding the terms of both types of financing is important.
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What is the difference between a credit card and personal loan?
A credit card is a revolving line of credit you can use at any time up to your credit limit. You are required to make a minimum payment each month, and have the option to pay more or pay it off every month. If you carry a balance, you will be charged interest.
A personal loan is a fixed amount that you borrow and pay back in equal installments over a certain amount of time. You are charged monthly interest from the time you sign the paperwork and receive the money. In most cases, you can pay back the loan before the end of the term without a penalty.
Credit card interest rates are typically higher than personal loan interest rates, although some cards offer zero or low interest for an introductory period. The rate you are offered on a credit card or personal loan will depend on your credit score.
Credit Cards: Pros and Cons
Credit cards are a convenient form of funding because they’re easily acquired, especially if you have good credit. You can take out a credit card ahead of time and have it on hand when needed.
This type of funding has advantages:
- Some credit cards offer low introductory rates, during which you aren’t charged interest.
- Credit cards are widely accepted, making it quick and easy to complete a purchase.
- When you pay off a portion of your credit card balance, you have the opportunity to borrow it again without having to reapply.
- Some credit cards offer cardholder rewards or benefits, such as free airline tickets or extended product warranties.
Credit cards have disadvantages:
- If you’re not disciplined, you could continue to add to your balance, which makes it difficult to get out of debt.
- If you choose a card with a zero- or low-interest introductory period and don’t pay it off before the promotion ends, your interest rate could end up being higher than a personal loan.
- Credit cards interest rates can be increased.
Personal Loan: Pros and Cons
A personal loan allows you to take a lump sum and pay it back over time. You can use it for any purpose, such as purchasing a vehicle, making a home improvement or consolidating debt.
This loan structure offers some advantages:
- Personal loans have upfront cost disclosures so you will understand interest and fees before you use the money.
- Personal loans have fixed monthly payments that can help you establish and stick to a budget.
- Most personal loans have a term that ranges from one to five years.
- Personal loans usually offer fixed interest rates.
- In most cases, you can pay off a personal loan early without penalty.
- As long as you make your regular payments, a personal loan will be paid off at the end of the term.
Personal loans do have disadvantages:
- Personal loans can be more expensive than credit cards if the lender charges fees based on the balance.
- Unlike credit cards that offer an introductory period with zero interest, personal loans don’t offer interest-free options.
- Interest rates on personal loans can be higher than secured loans, such as automobile loans or mortgages.
Is a credit card or a personal loan better?
How you use the funds, how much you need, and how good you are at repaying your debt can impact whether a credit card or personal loan is the better choice for you.
Credit cards may be a good option if you:
- Need funds available on a revolving basis.
- Make smaller purchases.
- Are disciplined and can pay off your balance in full each month.
- Have good credit and can qualify for zero-interest promotions.
Personal loans may be a good option if you:
- Need to borrow a large amount.
- Prefer a predictable monthly payment.
- Need a longer period of time for repayment.
- Would be tempted to reuse the available funds.
How debt consolidation works with credit cards and personal loans
Balance transfer credit cards and personal loans can be useful tools for debt consolidation. Some credit cards allow you to transfer the balance from another credit card, with offers of low or no interest for a set term. If you can pay off the balance within the introductory period, a balance transfer credit card may be a good choice for debt consolidation. Be sure to check if the credit card charges a transfer fee.
You can also take out a personal loan and use the funds to pay off other debt, such as loans with higher interests. This form of debt consolidation may extend the amount of time you have to pay off your balances and combine your amount into a single, lower payment. Another advantage is that a personal loan usually has a fixed interest rate.
Whether you decide to take out a personal loan or keep credit cards in reserve, make sure you shop around for the best interest rates and offerings. Loan product costs can vary greatly, and you want to be sure whatever you choose fits and furthers your financial goals.