Personal Loan vs Credit Card: Key Differences

When it comes to financing a purchase or consolidating debt, there are several options you can consider. Two of the most popular choices are credit cards and personal loans. But which one is right for you?

To help you make an informed decision, we’ll outline the key differences between credit cards and personal loans. In the pros and cons list, you may find your reason to choose one of the options and restrain from the other. We’ll also look into the potential impact they may have on your credit score. So, let’s dive in!

Personal Loan vs Credit Card: What’s the Difference?

Credit cards are a type of revolving credit, which means that the lender rotates a certain amount of money that can be used and paid down repeatedly as long as the account remains open. Essentially, you’re given a credit limit, and you can spend any amount up to the maximum and repay it in flexible installments.

Personal loans are installment loans and do not rotate. They have terms such as two years or five years, with fixed monthly payments scheduled to pay off the debt by the end of this term.

The best way to use a credit card is for small, everyday purchases because they can be paid off over time with no penalty if done so before the grace period. On the other hand, personal loans are more suitable for larger purchases such as home renovations and consolidating high-interest debt like a student loan or car loan debt.

Perks of Getting a Personal Loan

There are a few perks of getting a personal loan instead of a credit card:

• Lower interest rates: Personal loans typically have lower interest rates than credit cards.
• Provides funds in one lump sum: This makes personal loans a better funding option for larger purchases or projects.
• Higher borrowing limits: Personal loans also generally come with higher borrowing limits. This means that you can apply for a higher loan amount than what your credit card may provide.
• Fixed monthly payments: The installment nature of these loans allows for steady, even payments each month. This predictability makes it easier to stick to a budget.
• Remove temptation: Personal loans are a great option for those who don’t want to be tempted by revolving credit, as you won’t have access to any additional funds unless repaid and reapplied for again in the future.

Downsides of Getting a Personal Loan

Personal loans have some disadvantages as well:

• Monthly payments: Personal loans require monthly payments for their entire term, so this may not be the best option if you don’t have a steady income.
• Require collateral: Personal loans sometimes require collateral to secure the debt, while many credit cards don’t have this requirement. Yet, there are secured credit cards that require a deposit (often refundable) as collateral.
• Difficult to qualify for: Personal loans are generally more difficult to obtain than credit cards. They usually require a better credit score and higher income.
• No rewards: Unlike credit cards, personal loans don’t offer rewards.
  Lengthy approval: Personal loans can take longer than 24 hours to receive after approval. This could delay any immediate spending needs you might have.
• Overall cost: With personal loans, you pay interest on the whole amount from the start. Some lenders also charge origination, or upfront, fees, as well as prepayment penalties.

Perks of Using a Credit Card

Credit cards are a preferred financing method for many borrowers. Here are some of the main advantages:

• Rewards: Credit card companies often offer rewards programs with perks like cashback on purchases at specific stores, airline miles, and other bonuses.
• Easy access: Credit cards are a great option for those who have less than perfect credit and need to build up their score or just want access to revolving funds. There are viable options even for people with no or bad credit.
• Convenience: Credit cards are great for small purchases in-store or online.
• Ongoing revolving credit balance: This means you only pay interest when funds are used and not paid back by the end of the billing cycle.
• Intro deals: Many companies offer 0% introductory APR on new cards, so if you can pay the balance off in that promotional period (typically 12 months), you can avoid paying interest altogether.
• Flexible: With credit cards, you can tailor the monthly payment to suit you. You can pay off your balance in full, the minimum amount, or anything in between.

Downsides of Using a Credit Card

Credit cards have their fair share of downsides too:

• Debt accumulation: The main drawback of credit cards is that you can quickly accumulate debt if you’re not careful.
• Higher interest rates: Credit card interest rates tend to be higher than personal loan interest rates. So it’s important to make sure that you always pay your balance in full each month to avoid paying interest charges on top of what you’ve already spent.
• Additional fees: Credit card companies also often charge annual fees, late payment fees, foreign exchange fees, and returned payment fees. These can add up quickly over time.
• Continuous temptation: The ongoing access to credit, coupled with the convenience of using a credit card, may tempt you to continue racking up your balance.
• Restricted access to best perks: Some banks will only allow customers with good credit scores (700+) to qualify for their best rewards credit cards, so if you have a lower score, you may not be able to reap the benefits of these offers. Nevertheless, some types of credit cards are designed for people with less than stellar credit history.

Impact on Credit Score

The impact personal loans and credit cards have on your credit score depends on how you use them.

Carrying a credit card balance from month to month can cause your credit score to drop. The same goes for late or missed payments on your personal loan.

On the other hand, using a credit card for occasional purchases and then paying off the balance in full each month will help boost your credit score as it will show that you’re able to handle credit responsibly. Likewise, making timely monthly payments on your personal loan will go to your credit history and improve your credit score, allowing you to access other types of financing in the future, like mortgages.

That being said, one important factor to consider is your credit utilization ratio (ratio of how much credit you’re using compared to your total credit limit). This is a key factor that both lenders and credit scoring agencies look at when determining your creditworthiness.

Suppose you have a high utilization rate on any of your open lines of credit. In that case, it can indicate to lenders that you’re struggling financially and are unable to responsibly use the credit they’ve given you. This can lead to your credit score dropping, even if you’re making all of your payments on time.

The Bottom Line

In conclusion, it’s important to weigh all the pros and cons of both personal loans and credit cards when making a decision about which type of financing is right for you.

Personal loans can be a great option for those who want lower interest rates, fixed monthly payments, and don’t want to be tempted by revolving credit. Credit cards, on the other hand, are great for those who want to have access to a line of credit for small, everyday purchases and want to pay off the balance over time.

Whichever option you choose, make sure you read the fine print carefully and understand all of the terms and conditions before signing up!