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Personal Loans

How to Choose Between a Personal Loan and a Credit Card

Both personal loans and credit cards are financial tools that allow you to borrow money, and each can help you build credit when used responsibly. But loans and credit cards work very differently, so one may be better than the other for certain financial decisions. Deciding whether to get a personal loan or a credit card first depends on the types of purchases you plan to make as well as your financial situation.

What Is a Personal Loan?

A personal loan allows you to borrow a set amount and repay it in roughly equal monthly payments over a predetermined period of time. Loans are a form of installment credit and are typically used to make a large purchase or to consolidate debt. Most personal loans have a fixed interest rate, which means your monthly payment amount won't change over the course of the loan due to rate fluctuations.

Since loans have a preset repayment term of months or years, you know when it will be fully paid off. Your monthly payments go toward paying back the principal (the amount you borrowed) along with the interest. Loans also must be borrowed in set amounts, meaning you may end up with a loan that's larger than what you need—borrowing $2,000 to cover a $1,850 purchase, for instance.

Personal loans can be used for a variety of purposes, such as:

  • Wedding
  • Home repair or renovation
  • Medical procedure
  • Financial emergency
  • Debt consolidation

Most personal loans are unsecured, which means no collateral is required. This is in contrast to secured loans, such as an auto loan or mortgage loan, where the item you're financing is used as collateral. In other words, if you can't make payments on an auto loan or mortgage, you risk losing your car or house. Inability to repay an unsecured personal loan won't directly result in the loss of property, but it could have major consequences on your credit and land you in court.

Availability

While many large banks no longer offer unsecured personal loans, you've still got plenty of other borrowing options including smaller banks, credit unions and online lenders. In recent years, online lenders have ramped up their personal loan offerings and offer rates and terms that can outcompete many traditional lenders. They may also specialize in different lending scenarios, such as debt consolidation or serving borrowers who want quick money disbursement or have lower credit scores. You can apply online through various personal finance websites that let you shop and compare different options.

Impact on Credit

Just like any form of debt, personal loans can impact your credit both positively and negatively. Personal loan applications likely require a credit check, which puts a hard inquiry on your credit report that can cause a small, temporary ding to your score. You may also experience a temporary dip in your score when you receive the loan since it increases your amount of debt.

However, as you make your loan payments on time every month, that positive repayment history will begin to improve your credit. Late or missed loan payments, on the other hand, can severely hurt your credit score. Don't take out a loan unless you know you can repay it on time as agreed.

How Do Credit Cards Work?

Credit cards are a type of revolving credit. Whereas installment loans let you borrow a set amount of money and repay it over a specific term, credit cards let you borrow up to a certain limit, repay it and reborrow repeatedly.

You only pay interest on what you borrow if you carry a balance to the next month. When you do carry a balance, credit card issuers require you to pay at least a minimum amount every month.

Say you have a new credit card with a limit of $10,000. If you charge $2,000 on it for a car repair but pay off the balance before the end of your monthly billing cycle, you won't owe any interest. But if you can't pay it off in full, your remaining balance will carry to the next month and you'll owe interest when your statement comes due.

Be aware that monthly minimum payments may seem manageable, but if you only ever pay the minimum, it can take a long time to get out of debt—especially if the interest rate is high. That's because unlike a personal loan, credit cards don't have a set term by when the full balance has to be repaid. This means the repayment process is more flexible than with loans, but takes discipline to fully pay off.

Availability

There are many credit card issuers that issue different types of credit cards. And even if your credit score is on the lower end, or you're just starting out with credit, it's possible to find a credit card that works for you. There are, for example, student cards made for college students just getting started, and secured cards for those who need help building or repairing credit.

Credit cards can also come with useful perks such as rewards-earning features that let you earn cash back or free travel. Low-interest or balance transfer cards make it easier to pay down high-interest debt.

Some credit cards even come with 0% APR introductory offers of a year or longer. If you need to make a large purchase and pay it off over time, or if you have high-interest debt you need to consolidate, these types of credit cards can save you big bucks as long as you can pay off the balance before the regular APR kicks in.

If you're considering a credit card, understand the fees you'll pay. Some cards charge an annual fee, and charges for balance transfers and late payments are common. If you're intending to carry the card while you're traveling, read up on whether the card charges foreign transaction fees on purchases made abroad or in another currency and, if so, how much.

Impact on Credit

Like personal loans, credit cards also have the potential to make a huge impact on your credit score. Making on-time payments helps you build a positive credit history and improve your credit scores. Late or missed payments damage your score and could lead to other consequences, such as fees or an increased interest rate.

An additional factor to consider with credit cards is your credit utilization ratio, which indicates how much of your available credit you're using at any given time. Carrying a balance greater than 30% of your credit limit can start to bring your credit score down (and getting close to your credit limit, or even maxing out, can really hurt your score).

When Does It Make More Sense to Get a Personal Loan?

While personal loans don't offer much flexibility in terms of how much you can borrow, they can allow you to borrow more than you could with a credit card, making them optimal for major purchases. Plus, interest rates on personal loans are often lower than credit cards, especially if you have strong credit. However, those with not-so-great credit may still face high interest rates on loans.

A personal loan could be best for you if:

  • You need to finance a large purchase such as a wedding, surgery, home project or vacation.
  • You have excellent credit and are able to qualify for a lower interest rate.
  • You want predictable monthly payments.
  • You'll be able to afford the loan's monthly payments over the entire term of the loan.
  • You have a large amount of high-interest debt you need to consolidate (especially credit card debt).

When Does It Make More Sense to Get a Credit Card?

Credit cards are easy to use for small purchases and last-minute emergencies, like if you need some car urgent repairs but don't have enough cash to pay for them until your next paycheck. However, interest rates on credit cards are typically higher than those on personal loans, so carrying credit card debt can be expensive.

A credit card might be a better option over a loan if:

  • You want a way to finance smaller purchases or have a backup payment for emergencies.
  • You know you can pay off your balance in full every month to avoid interest charges (or at least the majority of it to minimize interest payments).
  • You can qualify for 0% APR promotional offers.
  • You want to earn rewards for your spending (To maximize your rewards, use a rewards card to make purchases you'd have already made, then pay off your card balance before it accrues any interest).

Get Matched With a Loan or Credit Card

If a personal loan loan or credit card sounds like the right fit for your financial situation but you're not sure where to start, try Experian CreditMatch™ for credit cards or CreditMatch™ for personal loans. We'll take a look at your credit score and provide free, customized offers.