Credit card or personal loan? The answer depends on what you’re buying and how you intend to pay it back.
When you’re in the market to make a major purchase but don’t have all the cash on hand, borrowing funds can be a viable route. It usually comes down to two options: credit cards and personal loans. Both have pros and cons, but choosing the one that best suits your financial situation could save you money in the long run.
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- No prepayment penalties
- Flexible loan terms
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Our top pick: LendingClub Personal Loan
- Min. Credit Score Required: 640
- Min. Loan Amount: $1,000
- Max. Loan Amount: $40,000
- APR: 6.95% to 35.89%
- Requirements: US citizen or permanent resident, verifiable bank account, steady source of income, ages 18+.
How do personal loans and credit cards work?
Personal loans and credit cards are both types of credit that you have to repay with interest. However, there are some differences between the two.
- Personal loans come in a lump sum. You have a predetermined amount of time to pay them off, usually between one and seven years. On top of interest, you might also have to pay application, origination, monthly or prepayment fees.
- Credit cards are a revolving form of borrowing, so they can theoretically last a lifetime. There’s a cap on how much you can borrow each month and you have to make at least a minimum monthly payment on your balance. Many credit cards charge annual fees but also come with interest-free grace periods, balance transfers and rewards.
Main differences between personal loans and credit cards
| Personal loan | Credit card | |
|---|---|---|
| Interest rate | Generally 2.99%-36.00% | Generally 13.99% to 22.99% |
| Repayment terms | Monthly | Monthly |
| Borrowing limit | Can be up to $100,000 | Can be as high as $50,000 |
| Funds disbursement | One lump sum upon approval | Revolving credit on card (cash advances available as well) |
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Benefits and drawbacks of a personal loan
Benefits
- Lower interest rates than credit cards
- Repayment schedule means your debt comes with an end date
- Can be cheaper in the long term
- No temptation to overspend
Drawbacks
- Minimum loan term means that you’ll carry the debt for more than a year
- Can be inflexible (may not offer early repayments)
- Can take longer to apply for
Suitable for
- Large one-off purchases like cars or home improvement
- Large debt consolidations
- Borrowing over a long period of time
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Benefits and drawbacks of a credit card
Benefits
- Immediate spending
- Can come with rewards
- Convenient option if you need a constant cash flow
- Balance transfer for debt consolidation
- Interest-free grace period
Drawbacks
- Usually carry higher interest rates
- Only requires a minimum repayment each statement period, which means your debt can accrue interest indefinitely
Suitable for
- Smaller purchases
- Small debt consolidations
- Everyday shopping or retail purchases to earn reward points
- Spending amounts that you can be paid back within the interest-free introductory period
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Personal loans vs. credit cards: Which one is right for you?
Personal loans vs. credit cards: Which one is right for you?There is no single answer to this question. While a credit card might be the right choice in one situation, a personal loan might be more suitable in another. And in a third situation, neither might be appropriate.
Here are some questions to ask to help decide which credit product might best meet your needs:
- What do you need the funds for? If you need money for a one-off expense, such as a large purchase, then a personal loan may be suitable. If you want continued access to credit, then a credit card may be a better option.
- How do you manage your repayments? Credit cards are an ongoing form of credit, while personal loans have an end date. If either a personal loan or credit card will work for your needs, you may want to consider how disciplined you are with repayments. If you think you may be tempted with the credit line sitting there, then a more structured repayment schedule, such as that offered by a personal loan, may be worth considering.
- Are you consolidating debt? It’s important to consider your options carefully. How much debt do you have and does it include loans and credit card accounts? Make sure you’ll be able to consolidate all of your account — for instance, only certain providers allow you to balance transfer loans to a credit card. You also have the option of consolidating your credit cards to a personal loan, which may be able to help you save.
- How much are you looking to borrow? Credit card limits differ, as do personal loan limits. Generally, with an unsecured personal loan you can apply for up to $100,000. You may be able to get a high credit limit with a credit card, but you’ll generally need to meet stricter eligibility criteria.
Financing home renovations
Imagine this scenario: Ashley recently bought a home and is looking to fund some renovations. Since she has no equity, she narrows her options down to a credit card and a personal loan. The personal loan has a term of four years, and Ashley decides she’ll calculate the credit card’s monthly payments based off the same term.
| Credit card | Personal loan | |
|---|---|---|
| Credit limit or loan amount | $7,500 | $15,000 |
| Interest rate | 19% | 6.5% |
| Monthly payment | $224.25 | $355.72 |
| Total interest paid | $3,264.04 | $2,074.77 |
Because Ashley has carefully budgeted for the home renovations, she knows she can afford the higher payments the personal loan requires. And since she can borrow more — while paying less in interest — Ashley decides to go through with the personal loan rather than the credit card.
How to compare personal loans and credit cards
- Interest rates. If you compare interest rates, generally personal loans are cheaper. The true cost is reflected in the APR, as you need to consider any fees as well.
- Fees. Personal loans may come with an application fee or origination fee, among other fee types. Credit cards usually just have the annual fee, if there’s a fee at all.
- Your financial situation. If you have good control over your spending and you regularly follow your budget, then a credit card could be suitable and even help you earn money through rewards and cash back. On the other hand, a personal loan offers the structure some people may need to repay debt timely.
How interest is calculated: Credit card vs. personal loan
Credit cards and personal loans might both come with APRs. But it doesn’t quite work the same way. With a personal loan, you’ll typically pay a percentage of your loan principal in interest each month — this amount can vary, especially if your loan is amortized.
With a credit card, you can effectively avoid paying interest if you’re able to pay off your balance each month. You’ll only pay interest when you have a balance that takes more than a month to pay off — which can take less time than a personal loan. So while credit card rates might be higher, they also come with the option of completely avoiding interest payments.
Using a personal loan or credit card to consolidate debt
Debt consolidation involves merging multiple debts into one loan or credit card. It simplifies your monthly payments and could save you money if you find a lower interest rate. There are two main ways to do this: With a debt consolidation loan or a balance transfer credit card.
- Debt consolidation loans are term loans used to pay off any kind of debt at a lower interest rate. Your lender either gives you the money to pay off your debt, or — more likely — asks for your payment information to do it for you.
- Balance transfer credit cards allow you to transfer all of credit card debt to onto a new card with a lower rate. They usually charge a one-time transfer fee, on top of annual fees, and often offer introductory rates that can be as low as 0%.
Bottom line
Personal loans and credit cards are two forms of borrowing that both offer attractive benefits and some notable drawbacks. Which you choose is ultimately up to you, and many people have used both at different points for different purposes. Be sure to compare your options to make an informed decision.
