Credit card or personal loan: Which is right for you?

The answer depends on what you’re buying and how you intend to pay it back.

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When you’re looking to make a big purchase but don’t have cash, borrowing can be a viable option. It usually comes down to two choices: 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.

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 key 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 or early repayment 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 an annual fee but also come with an interest-free grace period, balance transfer and rewards.

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 loanCredit card
Interest rate (with good credit)3% – 10%15% to 25% (but introductory rates of 0% are available)
Repayment termsFixed monthly paymentFlexible payments subject to a minimum amount
Borrowing limit£25,000£5,000
Receiving fundsOne lump sum upon approvalRevolving credit – borrow what you need when you need it
Payment protectionNo protectionProtected by Section 75 of the Consumer Credit Act

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
  • Those with less financial discipline

Benefits and drawbacks of a credit card

Benefits

  • Introductory offers of 0% interest
  • Immediate spending
  • Can come with rewards
  • Convenient option if you need a constant cash flow
  • Balance transfer for debt consolidation
  • Interest-free grace period
  • Only pay on what you borrow
Drawbacks

  • Higher interest rates after introductory offers expire
  • Only requires a minimum repayment each statement period, which means your debt can accrue interest indefinitely
  • Not good if you need cash
Suitable for

  • Smaller purchases
  • Those disciplined with their money
  • Small debt consolidations
  • Everyday shopping or retail purchases to earn reward points
  • Spending amounts that can be paid back within the interest-free introductory period

Personal loans vs credit cards: Which one is right for you?

There is no short 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:

personal-loan-vs-credit-card2

  • 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? As mentioned in the point above, 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 will be able to bring across all your accounts to consolidate – for instance, only certain providers allow you to balance transfer loans to a credit card. You also have the option of consolidating your credit card to a personal loan, which can 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 £25,000. You may be able to a high credit limit with a credit card but you will generally need to meet stricter eligibility criteria.

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 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 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

If you can get approved and have the discipline, a credit card with a 0% introductory offer can be a great borrowing option.

However, if you can’t get approved, intend to borrow for a longer time, or need a lump sum, personal loans offer certainty and a deadline on your debt.

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