Is there a difference between personal loans vs. credit cards?
Here are the basics:
If you need quick cash for one reason or the other, credit cards and personal loans have proven to be more liable over time. With either method, you will access money fairly quick and pay later with interest.
Unfortunately, choosing between credit cards and personal loans can be a daunting task. Whereas a credit card is better for short term loans, personal loans are often the choice for people who want larger amounts of money and longer payment time.
However, the choice of either will depend on a number of factors, most of which boil down to mere personal preferences.
Regardless of the option you settle on, you will want an option with the highest convenience and lowest costs possible.
In this article, we take a look at personal loans vs. credit cards focusing on their convenience and short comings. We’ll determine the one that is best for you depending on your financial situation.
Keep reading to learn more.
Personal loans and how they work
Personal loan is money advanced to you by a lender for your own personal use. Most often, it is unsecured.
The money is lent to you on the basis of your credit score, your income or ability to pay the money in the future.
It can also be secured by an asset, a guarantor or any other collateral.
An excellent credit score gets you a personal loan at low interest rates.
You can receive the same low interest rates if your credit score is worse of but you reinforce you risk with a collateral or a guarantor.
How personal loans work
Personal loans work different from credit cards in as much as they fulfill the same purpose.
When you apply for the personal loan, you will receive the whole amount you applied for in your bank account once approved. Thereafter you are allowed to withdraw it in cash as use it to fulfill your financial need.
You are then required to start repaying it for a specified period of time until when your loan balance is settled in full.
You therefore are supposed to start remitting fixed monthly payments for agreed period of time to your lender until your debt is settled.
Unlike credit card debt, there is no penalty for paying off your loan early.
Lately, you can apply for a personal loan entirely online.
Most lenders will require your personal and employment information and a proof of your income.
Typically, it takes one to two business days for your application to get approval. For some banks (and credit unions) may take just a few hours to approve your loan.
Once approved, you will revise the interest rate offered to you and payment terms. In case you agreed, then will you sign a promissory note and the money disbursed to your checking account almost immediately.
When to choose a personal loan
- You want to consolidate high interest debts
- Need to finance large purchases cheaply
- Your credit score is excellent (unsecured loans)
- Willing to make monthly payments over a longer period of time
Personal loans whether secured or unsecured generally offer lower interest rates. For most of the lenders, the interest rates range from a low of 5% to a high of 36%.
To determine what interest you get when you seek personal loan financing, your credit score, credit history and income and debt to income ratio (DTI) play a major role.
If your credit score is excellent, then you will end up borrowing cheaply. The interest rates charged on your loans will be close to the low of 5% as possible.
But, if your credit score is poor, you will need to improve it first or else you will end up paying rates close to the high of 36%.
However, there is a way to bypass this high interest rates. When you opt to secure your loan with some form of collateral (like your house, any other assets or savings), you receive will receive interest rates that are lower.
Personal loans benefits
- Personal loans usually have lower interest rates
- This makes them very good option for consolidating your debt
- You can apply for most of the entirely online or at the local bank (or credit union) near you.
- Personal loans can be secure or unsecured.
Personal loans drawbacks
- You are obliged to adhere to the set payment schedule.
- You will need a collateral or good credit score to qualify for better terms and low interest rates loans.
- It might be hard to qualify if you do not have a good credit history or an asset to secure your loan.
Credit Cards and how they work
Credit cards loans is the money you borrow every time you use a credit card to make purchases.
Just like personal loans, they provide a level of convenience in your regular expenditures.
Most often, credit card loans are unsecured type of loans. This means the money you borrow through your spending on the credit card is not attached to collateral (assets or savings) you have.
Therefore, you will need to have an excellent credit score to borrow at a lower annual percentage rate, APR.
However, there are secured credit cards which guarantee lower APR. This they are rare though.
When to choose a credit card
- You need to finance smaller expenses.
- When you are sure to pay off the balance in full each month.
- If you qualify for 0% promotional offer.
Credit cards are a good financing option for short term expenditures that lasts one month to a few months or if you qualify to a 0% promotional offers.
However, they can quickly become expensive and unreliable if you do not qualify for such promotions, have low credit score or if you cannot clear your balance on the month to month basis.
With higher risk of carrying a high balance, credit cards are better reserved for miscellaneous expenditures which you are so sure to clear by the end of the month.
Credit card benefits
- You can apply for a credit card at any time and use it when the need arises. You are required to however use it regularly in order to improve your credit utilization ration.
- They are the easiest to qualify for, as long as your credit score is above average.
- You can apply for a credit card online without visiting the credit card company.
- Some credit cards offer 0% interest on the transferred balance for a period up to 18 months. This makes it easy for you to consolidate your debt.
Credit card draw backs
- You are required to use the credit card often to improve your credit card utilization ration. This means more debt to be paid.
- Depending on your APR, the interest accrues really quick and you may risk falling into a debt trap.
- You need an excellent credit score to qualify for low APR cards or reward programs.
- While credit cards are flexible in your spending, it is not in cash withdrawals. You accrue more charges any time you decide to withdraw some cash from your credit card.
Personal loans vs. credit cards for debt consolidation
Personal loans and credit cards can both be used to consolidate debt. Consolidation allows you to get out of debt fast as you save on the interest.
When to go for personal loan:
Debt consolidation loan becomes your best tool if you have a large amount of debt and you need more time to offset it. But this is so if you can get a lower interest rate than the rate you paying currently.
When to go for balance transfer credit card:
If you have a smaller debt balance (relative to your income or around $15,000), a credit card balance transfer is the best option for you. it will allow you to consolidate your debt for an introductory APR of 0% for up to 18 months.
Given your small balance relative to your income, the 18 month is enough time to clear all your debt before the 0% APR offer expires.
Often, the amount of money you save at 0% interest outweighs the transfer fee to the new card which mostly stands at around 3% to 5% of the balance.
How are personal loans different from credit cards?
Is there difference between personal loans vs. credit cards?
- A credit card is a line of credit.
You can borrow money every time you need it until you reach your credit limit. A personal loan is amount of money deposited to your savings account by the lenders and is to be paid back in equal installments for an agreed period of time.
- A credit card has a credit limit.
You are allowed to spend up to the limit and repay it at the end of the month.
If you don’t clear the balance at the end of the month, it rolls over to the next month. You will pay interest on the balance carried over and still be able to make new purchases.
- Personal loans are fixed.
You are able to receive a fixed amount of money into your savings account which you will then spend as you wish. The amount is however limited to the one disbursed to you. in any case you need more, you will have to clear the loan balance first and/or applied for another loan product.
When is credit card better than personal loans?
Credit cards are better in making smaller short term purchases or expenditure. You can also use it to consolidate short term debt (less than a year).
If you plan to spend a few hundred dollars, a credit cards will be more convenient compared to a personal loan.
You should look for 0% APR credit card (introductory offer) where you will pay no interest for a specified period of time. Make sure to clear all the balance before the introductory offer period expires and interest swings into action.
Similarly, if you want to consolidate your loan, you can use credit card balance transfer option. you are allowed to transfer your other cards balance to a new one where you enjoy 0% interest for up to 18 months. If you owe less than $10,000, 18 months is enough time to clear off the balance without accruing interest.
When is personal loan better than a credit card?
Personal loans are better option for larger purchases that require more than a year to repay.
If you need to borrow $5,000+ (which is above most credit cards limits) a personal loan is the best option for you. It does not only offer higher credit limit but also longer payment periods. With personal loans, you can borrow as high as $100,000 and repay it for as long as 10 years.
They are therefore the best financing option if you want to get out of debt once and for all through debt consolidation mechanism.
How to find the best personal loans
The best personal loans providers require you have above average credit score. Most of them are transparent with the fees and interest rates they charge (which are often fixed) for the period of the loan.
However, even with a bad credit score, there are a number of lenders that cater for you and charge relatively low interest rates (always lower than the credit cards APR).
If you have any more questions relating to personal loans vs. credit cards, let me know in the comments below.