Both personal loans and credit cards let you borrow money. They come with many similar features: applications, credit checks, fees, interest rates, payments, and more. They are still very different kinds of credit with very different purposes.
Let’s look at personal loans. credit cards, and when it makes sense to use each one.
What Is A Personal Loan?
A personal loan is an installment loan. You borrow a fixed sum and pay it back, with interest, in equal monthly payments. Most personal loans are unsecured: they do not require collateral.
A personal loan is not tied to a specific purpose. You can typically use them for any legal purpose. Popular uses include debt consolidation, home repairs, travel, weddings, other celebrations, and many more.
These loans are available from banks, credit unions, and online lenders. The lender will check your credit score, debt to income ratio, and other factors before making an offer.
Personal loan lenders will typically lend up to $50,000 or more to qualified borrowers. Loan terms range from three to five years. The average interest rate is around 10% but may be much higher or lower depending on your creditworthiness.
What Is A Credit Card?
A credit card is a revolving credit line. You can draw on the credit line repeatedly as long as you stay below your credit limit. As long as you make minimum monthly payments, the credit line will remain open.
Credit cards carry high interest rates. The average US credit card carries an APR of 19.07%, and borrowers with lower credit scores may pay close to 30%.
Interest is only charged on balances held beyond the due date. If you pay your balance in full before the due date, you won’t pay any interest at all.
Credit card debt, like personal loan debt, is unsecured. You do not need collateral.
The Difference Between a Personal Loan and a Credit Card
The key distinction between a personal loan and credit cards is they are different kinds of credit.
- Credit cards are revolving credit. This means you can borrow money repeatedly on the same account. As long as your total debt is below your credit limit and you make minimum monthly payments, you can keep making charges against the account.
- Personal loans are installment loans. You receive your money in a lump sum and then repay the loan in equal installments over time.
Neither of these types of credit is inherently better or worse than the other. They have different purposes, and you will use them for different things.
When to Use a Credit Card vs. Personal Loan
Personal loans are typically used for major purchases, while credit cards work best for small daily expenditures.
You generally won’t have to choose whether to use a personal loan or a credit card. The situation will choose for you:
- If you want to pay for a large expense that you want to pay off over an extended period, use a personal loan.
- If you are making routine purchases that you can pay off relatively quickly, a credit card is a better choice.
There is one situation where you might need to choose between a personal loan and a credit card. That deserves a special look.
Debt Consolidation: Personal Loans vs. Credit Card
If you are carrying several different high-interest debts, you may have considered debt consolidation to simplify your payment schedule and reduce your interest rate.
Personal loans and balance transfer credit cards are both popular ways to consolidate debt:
- To consolidate debts with a personal loan, you take out a personal loan, use the money to pay your other debts, and pay off the personal loan.
- To consolidate debts with a balance transfer card, you find a card with an interest-free period for balance transfers. You transfer the balances to that card and pay them off before the interest-free period expires.
The key difference here is the term of a personal loan vs. the length of the interest-free promotion on a balance transfer card.
- Personal loans are often available with terms of three to five years.
- Balance transfer cards usually have an interest-free period of 12 to 18 months. After that, you will pay a regular (high) credit card rate.
If you can pay off your debts within that 12 to 18-month period, a balance transfer card is a better choice. You’ll pay no interest at all.
If you need more time, a personal loan is a better bet.
Remember to be realistic in assessing your payment ability!
You will need good credit to get a personal loan on competitive terms, and most balance transfer cards also require good credit. If your credit is not good, you may need to look for other ways to consolidate debt.
Let’s Sum That Up
Personal Loans and credit cards are different types of credit with different purposes.
If you want to borrow a lump sum of money and pay it back over an extended period, a personal loan will serve you best. If you’re looking for a convenient way to make day-to-day purchases that you can pay off quickly, a credit card will be your best option.
You’ll get better deals on both types of credit if you maintain a good credit score, and as with any form of credit, borrowing carelessly can get you into trouble. Always know your limits and borrow only what you can afford to pay!
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