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Personal loan vs credit card: Which is right for you?
Personal loans and credit cards are both popular ways to borrow money, but there are key differences between the two.
If you’re looking to make a large purchase but don’t have the cash to pay for it upfront, you might be considering borrowing the funds. Depending on the purchase you need to make, you could use either a personal loan or a credit card. Both have a number of benefits and drawbacks. Here, we explain how they work so you can decide what’s right for you.
How do personal loans and credit cards work?
Personal loans enable you to borrow a lump sum of cash that you then repay over a set term in fixed monthly instalments. Interest will be added on top.
You can typically borrow between £1,000 and £15,000 with a personal loan, although some providers will let you borrow up to £25,000. Repayment terms tend to vary between 1 and 7 years. Should you want to pay back your loan before the end of the term, you will usually need to pay an early repayment charge. In some cases, there might also be an application fee.
A credit card, on the other hand, gives you access to a flexible line of credit. That means you can borrow up to your set credit limit whenever you want to. Credit limits can vary from a few hundred pounds to a few thousand.
Repayments are also flexible rather than fixed. You’ll need to pay off a minimum amount each month, but how much you pay on top of that is up to you. However, if you don’t pay off your balance in full each month, you’ll usually pay interest on the amount you haven’t repaid.
When should you use a credit card?
A credit card will generally be the better choice for regular spending or if you are borrowing smaller amounts. Credit cards can also be a good option if you want to have some flexibility over repaying the debt.
Using a credit card will also give you purchase protection. Under Section 75 of the Consumer Credit Act , all credit card purchases costing more than £100 and up to £30,000 will be covered, even if you only pay for part of the purchase with your card. This means your credit card provider is jointly liable with the retailer in the event that the item doesn’t turn up or is not as described.
As well as purchases, credit cards can also be beneficial if you want to consolidate existing card debt. You can transfer credit card debt across to a 0% balance transfer credit card and benefit from several months of interest-free payments. This can help you to clear your debt faster and more cheaply. Just watch out for transfer fees.
When should you get a personal loan?
Personal loans can be a more suitable choice if you need to borrow a larger sum of money. You might want to use one to pay for essential home improvements, for example. They can also be a better option if you’re on a budget and prefer having fixed monthly repayments.
Personal loans can also help you to consolidate several different types of debt. You use the loan to pay off your existing borrowing and then only have one repayment to make each month to the one lender. This can make it much easier to manage and, if you’ve been able to secure a competitive loan rate, it can also work out cheaper.
How interest works
Credit cards come with what’s known as a “grace period”. This period is typically around 56 days and runs from the start of your billing cycle. During this time, you don’t have to pay any interest on your purchases. Your provider will send you a monthly bill showing you how much you owe at least 21 days before your payment is due. If you pay off your balance in full, you won’t pay any interest at all.
However, if you can’t do this, you must pay at least the minimum monthly repayment and interest will usually be charged on the remaining balance. Some credit cards offer separate 0% promotional deals for several months, meaning you won’t pay interest on any of your purchases during that time.
Personal loans, on the other hand, always charge interest and it will be applied to your monthly payments. The interest rate is usually fixed but some loans offer variable rates. Interest rates on personal loans tend to be lower compared to those for credit cards, with the best rates typically being on loan amounts of £7,500 or more.
Bear in mind that the advertised annual percentage rate (APR) for both credit cards and personal loans is “representative”. This means that at least 51% of successful applicants will get the advertised rate, but the remaining 49% might be charged a higher rate. You’re more likely to get the advertised rate if you have a good credit score.
Popular uses
Credit cards are often used to pay for the following:
- Online shopping
- Flights and holidays
- Supermarket shopping
- Large one-off purchases
Personal loans are often used to pay for the following:
- Home improvements
- A new car
- A wedding
- Debt consolidation
What are the main differences between personal loans and credit cards?
Rates, terms and limits are mostly subject to personal circumstances. We’ve filled out a table with some of the typical figures you’re likely to see:
| Personal loan | Credit card | |
|---|---|---|
| Interest rate (with good credit) | 5–10% | 20–25% (but introductory rates of 0% are available) |
| Repayment terms | Fixed monthly payment | Flexible payments subject to a minimum amount |
| Borrowing limit | £25,000 | £5,000 |
| Receiving funds | One lump sum upon approval | Revolving credit – borrow what you need when you need it |
| Payment protection | No protection | Protected by Section 75 of the Consumer Credit Act |
How satisfied are Brits with their card/loan provider?
| Response | Personal loan users (%) | Credit card holders (%) |
|---|---|---|
| Very satisfied | 37.22% | 46.36% |
| Reasonably satisfied | 45.53% | 36.69% |
| Neither satisfied nor dissatisfied | 12.90% | 12.32% |
| Moderately dissatisfied | 2.61% | 3.36% |
| Highly dissatisfied | 1.74% | 1.26% |
Source: Finder survey by OnePoll of 750 Brits
What are the pros and cons of a personal loan?
Pros
- Lower interest rates compared to credit cards
- Repayment schedule means your debt comes with an end date
- Fixed repayments can help you budget
- No temptation to overspend
Cons
- You’ll need to know exactly how much you need to borrow
- Minimum loan term means you’ll carry the debt for more than a year
- Paying off your loan early usually attracts a fee
- Can take longer to apply for
Suitable for
- Large one-off purchases such as a new car or a home extension
- Large debt consolidations
- Borrowing over a long period
- Those with less financial discipline
What are the pros and cons of a credit card?
Pros
- Some cards offer 0% introductory periods
- You might be able to benefit from rewards and cashback
- Convenient option if you need a constant cash flow
- Balance transfer cards for debt consolidation
- Interest-free grace period
- Flexible repayments
- Section 75 payment protection
- Only pay interest on what you borrow
Cons
- Interest rates can be higher than personal loan rates
- With no fixed end date, there’s an ongoing temptation to spend
- Minimum monthly repayments are low, so your debt could take a long time to repay and be expensive
- Some credit cards come with annual fees, cash withdrawal fees and foreign transaction fees
Suitable for
- Those who are disciplined with their money but want some flexibility
- Small debt consolidations
- Everyday shopping or retail purchases to earn rewards
- Spending amounts that can be repaid within the interest-free introductory period
Personal loans versus credit cards: Which one is right for you?
There’s no one answer to this question. The right choice for you will depend on your circumstances and how much you need to borrow. To help you decide whether a credit card or personal loan is right for you, here are some questions to consider:
- What do you need the funds for? If you need money for a large, one-off purchase, such as home improvements, 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 want to manage your repayments? Think about how disciplined you are with repayments. If you’d prefer to stick to fixed monthly repayments over a set time frame, a personal loan is likely to be more suitable. If you’re happy to be more flexible with your repayments, a credit card could be worth considering.
- Are you consolidating debt? If you are, you need to think about how much debt you have and whether it includes loans and credit card accounts. Make sure you will be able to bring across all your accounts to consolidate – if you have several different types of debt, a personal loan will likely be better.
- How much are you looking to borrow? Credit card limits differ, as do personal loan limits. Generally, with an unsecured personal loan, you can borrow up to £25,000. Credit card limits are usually much lower, with the highest limits being reserved for those who meet stricter eligibility criteria.
How to compare personal loans and credit cards
When comparing personal loans and credit cards, it’s important to consider the following:
- The interest rate. Personal loan rates tend to be cheaper than credit card interest rates, but this will depend on the amount you want to borrow. Smaller borrowing amounts (£5,000 or less) are usually more expensive for personal loans, while you might qualify for a 0% introductory offer on a credit card. Remember that the best interest rates are usually offered to those with good credit.
- Fees. Some personal loans have an application fee and there will usually be a charge if you pay off your loan early, so make sure you check. Some credit cards have annual fees, particularly if they offer rewards. If you’re applying for a balance transfer card, you will also usually have to pay a transfer fee of around 3%.
- Your monthly repayments. When comparing personal loans, it’s important to work out what your monthly repayments will be to ensure you can afford them – remember, these are fixed so you must pay this amount each month. If you’d prefer some flexibility, a credit card might be more suitable, but it’s best to pay off more than the minimum monthly repayment if you can.
How to compare personal loans and credit cards
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 2 main ways to do this – a debt consolidation loan or a balance transfer credit card.
- Debt consolidation loans enable you to pay off several different types of debt over a set term, ideally at a lower interest rate. You use your loan to pay off your existing debts and then repay the amount borrowed to your new lender in monthly instalments. It can be much easier to manage your debt this way as you will only have one payment to make each month.
- Balance transfer credit cards. Some personal loans have an application fee and there will usually be a charge if you pay off your loan early, so make sure you check. Some credit cards have annual fees, particularly if they offer rewards. If you’re applying for a balance transfer card, you will also usually have to pay a transfer fee of around 3%.
- Your monthly repayments. When comparing personal loans, it’s important to work out what your monthly repayments will be to ensure you can afford them – remember, these are fixed so you must pay this amount each month. If you’d prefer some flexibility, a credit card might be more suitable, but it’s best to pay off more than the minimum monthly repayment if you can.
How interest is calculated: Credit card vs personal loan
Credit cards and personal loans might both come with APRs. But they don’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 amortised.
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 2 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 enable you to shift all of your existing credit card debts onto a new card with a lower interest rate. You will usually need to pay a transfer fee that will be a percentage of the amount you’re transferring. However, you might be able to benefit from an introductory 0% deal that will enable you to avoid paying interest on your debt for a number of months. Just make sure you clear your balance before the 0% deal ends or get ready to transfer it to another 0% balance transfer card.
Things to consider
Before taking out a personal loan or credit card, ask yourself the following questions:
- Do you really need to borrow the funds? If it’s for something you could live without, it might be best to avoid getting into debt.
- Have you checked your credit score It’s worth using a fee-free service to check your credit score as the better it is, the more likely you are to qualify for the best deals. If your credit score is poor, there are steps you can take to improve it, such as paying bills on time and correcting any errors on your credit report.
- Can you afford the monthly repayments? Always check what they will be before applying to ensure you can pay back what you owe on time.
- What fees will you be charged? Whether it’s an application fee, a balance transfer fee or an annual fee, make sure you don’t get caught out.
Bottom Line
Personal loans and credit cards are both popular options when it comes to borrowing money, but it’s important to work out which option is right for you. Personal loans can be better for those borrowing large sums of money, but you must ensure you can meet your repayments each month as these are fixed.
Credit cards, on the other hand, can be better for smaller borrowing sums or for regular spending. Payments are flexible too, but remember that you will still need to pay off at least the minimum amount each month. Paying off more than this will help you to clear your debt faster and save money on interest.
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