Personal Loans or Credit Cards: Which One to Choose

If you’re comparing the pros and cons of personal loans and credit cards to help you make a decision, it’s probably safe to assume that you’ll be making a big financial commitment in the near future. A decision like that usually comes with a few headaches, but fortunately, choosing how to finance this decision doesn’t have to be one of them. Some of the factors, like the interest rates, aren’t entirely up to you; but knowing what you’re getting into will help you feel satisfied with the choice you’ve made. 

Flexibility vs. Accountability

The convenience of credit cards can be both a blessing and a curse. Any expense, no matter the size, is so easy to simply put on a credit card. If you decide to put a charge on your card that’ll take a considerable amount of time to pay off, you won’t have any deadlines or steep monthly payments to keep up with. You can set your own schedule to pay off the balance, and if something happens one month and you can’t pay as much as you wanted, no problem. Just do what you can, and next month you can hopefully pay more. That’s the “blessing” part. The “curse” part is what happens if you don’t get the balance down fast enough: you end up drowning in interest charges. The way credit cards are set up, you have incentives to get the balance up (in the form of cardholder rewards), but the incentive to get the balance back down is up to you. 

In contrast to credit cards, personal loans are scheduled and structured from the get-go. When you and the lender agree on how much you’ll be borrowing, you also agree on how fast you’ll pay it back. Once you’ve signed on the dotted line, you’ve agreed to pay off the debt by a certain deadline. You can pay it back faster than agreed, but not slower; the lender won’t care if you missed some work when an out-of-town friend was visiting, or if your car broke down and needed expensive repairs. When you get a loan, you’re committing to pay at least a certain amount every month, no matter what. 

Fixed Rates vs. Individually Calculated Rates + Fees

One aspect of credit cards that’s just impossible to like is their interest rates. At an average of 16%, interest fees on your card’s balance start to hurt pretty quickly; once your balance gets into the thousands, the monthly interest charges alone could easily grow beyond your ability to pay. That’s the disaster scenario, though. You won’t have to deal with this if you don’t let it happen; just make sure that if you put a huge expense on your card, you can start paying it off in sizeable chunks almost immediately. Thanks to credit cards’ fixed rates, you’ll be paying the same rate no matter what your score looks like. On the other side of the coin, 16% interest might be the best deal you can get if your score can’t get you a better rate anywhere else. 

If you have a good or excellent credit score, then you should be able to get much better interest rates with a loan. You’ll also be paying up to 8% of the lender’s fees, but this fee goes down the bigger the loan total is. Assuming that you’ll be borrowing a considerable amount, even a slightly-above-average credit score should help you secure a better rate than any credit card could offer. 

Hurts Your Credit Score vs. Helps Your Credit Score

It’s probably no surprise that credit scores are closely linked to credit cards. In a nutshell, the credit card habits that lead to a better credit score are 1) spending a lot of money on your card, and 2) paying the entire balance every month. Using your credit card as a way to carry debt means that you’ll be demonstrating the first habit just fine, but not the second one. If you’re paying it off fairly quickly it shouldn’t be too much of a problem, but if you aren’t able to keep up, that could seriously damage your overall score. Once credit reporting agencies see a trend of someone spending more than they’re paying back, they conclude that this person has a tendency to financially over-commit. If this trend continues for too long, establishments like banks and private lenders will be a lot more cautious about loans or credit limits. 

Credit scores aren’t just associated with credit cards; they’re also influenced by things like loans and mortgages. If you’re approved for a loan and keep up with the payments, that can actually help your credit score go up. Credit reporting agencies can see that not only were you approved for a loan, but that you paid it off on time; this is a solid indication that you can handle multiple debts at once. If credit reporting agencies can see this trend in your borrowing habits, so can other establishments; next time you decide to get a loan, you shouldn’t have any problem getting a lower interest rate. 

One handy little loophole that a small percentage of people could use is the 0% interest credit card. As a part of their user rewards, some credit card companies offer 0% interest rates for the first year or 18 months. If you’re looking at borrowing an amount that could take two years to pay back, this means that you’ll be completely avoiding interest fees during the time when they’d normally be the highest. You could apply for a new card that comes with 0% interest, or use one that you already have – just confirm that applying for a new card won’t negatively affect your overall credit score. 

Hopefully, this has given you enough information to move forward. Maybe you’re ready to make your decision, or maybe you’re about to go research lender’s fees and credit scores. Wherever you’re at in the process, just remember that the most informed decision is probably the best decision.

A Quarter Richer is a personal finance blog with informative articles and advice on improving spending habits and other financial matters.