Personal Loans vs. Credit Cards

Published on

March 1, 2021

If you need to borrow money to make a major purchase, should you apply for a credit card? Or is a personal loan the better option?

If you ask a credit union rep, they’ll say the answer depends on several factors, including interest rates, the amount of your required monthly payments, terms of repayment, and more.

Continue reading to learn more about the ins and outs of personal loans vs. credit cards.

Credit cards offer a revolving line of credit

A revolving line of credit means you can keep borrowing money as you pay down your balance. This is a perk you won’t get with a personal loan.

So if you’re interested in borrowing to furnish a house or decorate a dorm room, a credit card will allow you to keep making purchases as long as you make minimum monthly payments on time and don’t go over your credit limit.

But if you plan to use your credit card for a major purchase like furnishing a house but aren’t sure you will be able to pay off the balance within 12 months a personal loan might be a better option for you.

Personal loans provide a single, lump-sum payout

When you take out a personal loan, you’ll receive the money in a lump-sum payment to spend how you see fit. Unlike car loans or home loans, you’re not restricted in how you spend the money. However, once you’ve spent the loan amount, your payments do not buy you more credit. Instead, they go toward paying off the loan in its entirety.

Compare rates carefully

When comparing personal loans and credit cards, understanding the interest rate and any fees involved is an important consideration.

Average interest rates on personal loans and credit cards depend largely on your credit score and can vary by lender. In almost every situation, the higher your score, the lower your interest rate.

Personal loan interest rates currently range from about 5 percent to 36 percent, depending on your credit score. The better your credit score, the more likely you are to qualify for a personal loan with the lowest interest rate available. If your credit score needs work, you can expect ranges in a much higher range. In addition, it can be difficult to procure a personal loan if you have credit troubles.

The same holds true for credit cards. However, rates from credit unions like TEG FCU are often generally much lower and do not go above 18%. It is important to note if you make late payments on a credit card, you will also be charged a late fee and your rate will likely increase.

Rates can vary sharply from lender to lender so it definitely pays to shop around to make sure you are getting the best possible rate.

Personal loans may require a higher monthly payment

Though your interest rate may be lower on a personal loan, your minimum monthly payment may actually be higher, depending upon the loan’s term.

Short-term loans allow fewer months to pay them off, therefore the monthly payments are more substantial than most credit cards, however, knowing exactly what you owe each month, and for how long, can be helpful for planning your monthly budget.

Both credit cards and personal loans are subject to fees

Personal loans may generate origination fees and penalties for prepayment.

Credit cards are subject to late fees and over-the-credit-limit fees.

Regardless of which form of loan you choose, make sure you understand all the terms regarding how and when you’re required to repay them. Read over the fees involved and ask questions if you see something you don’t understand.

Credit cards may entice you to spend more

Having a credit card in your wallet feels like instant cash. As a result, you may find yourself more prone to impulse buys than you would be if you only carried cash.

Many people can juggle multiple cards responsibly. Others use their credit cards to keep themselves in an unintentional cycle of debt. Be cautious with your credit card and make conscious efforts to use it wisely so you don’t spend more than you can pay back in a reasonable amount of time.

A good rule of thumb is to look at the credit limit on your card, and try not to spend more than 25% of the card’s limit. If you have a plan to pay the balance down over a short period of time, this 25% rule is slightly less important. But overall, utilizing 25% or less on your card’s balance will keep your credit score higher and your budget in check.