Is Personal Loan Debt Better Than Credit Card Debt?

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Your car unexpectedly needs major repairs. You've been hit with a big medical bill. A friend invited you on the vacation of a lifetime—with a price tag to match. In short, you need a chunk of money quickly to cover a big expense. How should you get it: with a personal loan or a credit card?

Both methods can be used to finance large purchases or unexpected expenses, but whether a personal loan is better than credit card debt depends on several factors, including how much money you need, how soon you want to pay it back, and what you're using it for. Keep reading to find out when you should use a personal loan, when it's best to use a credit card, and the pros and cons of each.

When to Use a Personal Loan

A personal loan is an installment loan. With this type of loan, you borrow a set amount of money for a specific amount of time and make fixed monthly payments ("installments") until the loan is paid off. Once the loan is paid in full, it's considered closed; if you want to borrow more money, you have to apply for a new loan.

You can get personal loans from banks, credit unions or online lenders, and use them for any purpose you want. Some people use personal loans to pay for vacations, home renovations and weddings. Others take out personal loans to pay off other debts. For instance, you might take out a personal loan to pay off a large credit card balance at a lower interest rate, or to consolidate a lot of different debts into one monthly payment. (This type of personal loan is called a debt consolidation loan.)

What are some of the benefits of personal loans compared with credit cards?

  • You have fixed monthly payments, which makes it easier to budget.
  • If you have a good credit score and stable income, you can generally get a personal loan at a lower interest rate than a credit card. While interest rates vary widely, personal loans can currently be found with interest rates as low as 6%.
  • Personal loans generally go up to $50,000, more than the average credit card limit.
  • You get a lump sum of cash, so you can pay companies or individuals that don't accept credit cards.

However, personal loans can have some downsides too:

  • Fixed monthly payments mean less flexibility than you have with credit cards. Even if you're short of cash one month, you still have to make your full payment.
  • You have to pay origination fees (a percentage of the total loan amount) to take out a personal loan.
  • Paying less than the full monthly loan installment may be reported as a late payment to credit reporting agencies, hurting your credit scores. You may also be charged fees for late or partial payments.
  • If you want to pay off the loan before its end date, you might have to pay a prepayment fee.

When considering a personal loan, always compare a wide variety of lenders and be sure you understand all the costs involved, including the interest rate, origination fees and any other fees or penalties.

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When to Use a Credit Card

A credit card is a revolving credit account. You can charge up to a maximum amount of money (your credit limit) and can carry a balance ("revolve") from month to month; you're charged interest on that balance. The minimum payment you must make each month varies depending on how much credit you've used. You decide how much you want to repay each month beyond the required minimum.

What are some of the benefits of credit cards compared with personal loans?

  • As long as you have a credit history, it's fairly easy to qualify for a credit card. Even if you don't have a credit history, you may be able to get a secured credit card or starter card.
  • Credit cards offer flexible payment options. If you're short of cash and can't pay off the balance in full one month, you can just pay the minimum.
  • Some credit cards offer rewards, such as travel miles or cash back, based on your spending.
  • If you pay off your balance in full each month, you won't accumulate any interest.
  • If you currently have a balance on a high interest credit card, you may be able to transfer the balance to a balance transfer card that offers 0% interest for a certain period of time.

Of course, there are some downsides to credit cards too:

  • Credit cards generally have higher interest rates than personal loans. (The average credit card currently has an annual percentage rate, or APR, of more than 17 percent.) If you carry a large balance, interest charges can add up quickly.
  • Credit cards typically charge late fees; many charge annual fees as well.
  • If you make a late payment or miss a payment, the card issuer may raise your interest rate.
  • If you want a lump sum of cash, you'll need to take a cash advance on the card, typically at higher interest rates than making a purchase with the card.
  • If you're having trouble managing your money, credit cards can tempt you to spend more than you can afford to pay off.

If you need a relatively small sum of money—say, between $1,000 and $5,000—a credit card may be a better option than a personal loan. For example, getting a personal loan to get your car repaired is probably overkill. To find the best credit card for you, consider the credit limit you'd like, what you plan to use the card for, and whether you expect to carry a balance from month to month. Then compare a variety of credit cards, making sure you understand their interest rates, fees and terms. Experian's tools can match you up with credit cards you're more likely to qualify for based on your credit profile.

How Personal Loans and Credit Cards Impact Your Credit Scores

Besides giving you money, personal loans and credit cards have an additional benefit: They can boost your credit scores. Making your payments on time every month will help prove that you're doing a good job at managing your debt.

If you use credit cards, keeping your credit utilization ratio below 30% will also improve your credit scores. Your credit utilization ratio measures the percentage of revolving credit you have available that you're actually using. The lower your ratio, the better.

A personal loan adds variety to your credit mix, which is one of the factors used to determine your credit scores. And if you use a personal loan to pay off credit card debt, you'll reduce your credit utilization ratio.

Keep in mind that both personal loans and credit cards can also hurt your credit. Making late payments or missing payments can lower your credit scores, making it more difficult to get credit in the future.

Make an Informed Decision

Is a personal loan or a credit card the answer to your prayers for a cash infusion? Only you can make that decision. Whichever option you choose, be sure to do your homework. Compare different loans and credit cards—considering interest rates, repayment terms and fees—to find the option that not only helps you pay for that dream vacation, major plumbing repair or tax bill, but also makes long-term financial sense for you.