When life’s expenses crop up, it’s always best to pay with cash. When tough times come our way, many people will need to borrow for emergencies, and in worst-case scenarios, for everyday purchases. The big question is whether a credit card or personal loan makes the most sense. Beyond the necessity of using a bank’s money, you’ll want to be sure you can afford to make the payments, which are based on interest rates, length of the loan and other terms and conditions. You’ll want to compare your options to determine which will cost you less, bank credit card or bank loan.
The difference between borrowing with a credit card and taking out a personal loan may not be obvious to consumers who have little experience with either one. But knowledge is money, especially when it comes to using someone else’s. Here’s what you need to know to make the right decision.
What They have in Common
Both offer unsecured ways to get the cash you need. Whether you take out a personal loan or use a credit card, most people utilize them as unsecured, meaning no collateral is required. You will be given a specific spending limit and generally be allowed to use the money for any purpose. Credit card issuers and lenders that provide credit and personal loans are in the business of raising revenue and their main source is from interest charged on the accounts for as long as a balance remains.
The common variables that make up both credit card and personal loan agreements include how much you can borrow, the rate of interest that will incur, how it is calculated and the amount of penalty fees for reneging on the agreement, i.e., making a late payment.
Revolving Account vs. Fixed Loan
The biggest difference between using a credit card and a personal loan is that the allowable credit limit on a credit card is more flexible. You can choose to pay the entire balance off at the end of the month or ‘carry a balance’ and make smaller payments over time. For example, with a credit limit of $1,000 you can spend the whole shot, pay off a big chunk and use the remaining balance to purchase again.
With a personal loan, the funds are depleted as you pay down the balance until it reaches zero. If you stop paying on an unsecured personal loan, the bank can’t repossess anything, as they would be able to repossess a car in the event that the payments become neglected. For this reason, personal loans have higher interest rates than car loans.
- Best Use for Credit Cards: Even though credit card rates may be higher than loans, the convenience of using plastic for smaller purchases makes sense because it can be repaid quickly. Using a low or 0% APR credit card makes it even more practical.
- Best Use for Personal Loan: Large ticket items that may require advanced planning and careful consideration before buying, those that will take time to pay off, such as a used car, honeymoon, appliances and technology, are best paid for with a low-interest loan. They generally have lower interest rates and longer borrowing periods than credit cards.
Why a Credit Card May be a Bad Choice
Used with caution, a credit card is a convenient way to pay for the things you need. Without a clear understanding of the damage that can come from mismanaging a credit account, many people end up over their head in debt. With credit cards, it’s easy to get stuck in the minimum payment trap, never making headway on your balance and throwing money away on never-ending finance charges. Anyone who may be vulnerable to using a credit card unrestrained may want to consider getting a small loan with fixed payments for those things they need to borrow for. In this way, they won’t have the opportunity to overspend.
Why a Loan May be a Bad Choice
Taking out a loan is serious and should be reserved for those times when paying with cash is out of reach and an item is a necessity rather than a frivolous desire. A loan is a bad option when your budget is already stretched tight and the potential for defaulting on the payment is high.
If a loan is an absolute necessity, there is one way to help make it easier to handle. Apply for a secured personal loan that uses your home or other valuables as security and enjoy lower rates and a longer time to pay it off. Never borrow for trivial, hasty or compulsive desires. Going into debt for your heart’s desires is risky.
If the amount you need to borrow can be paid off in a year, consider one of the generous introductory 0% APR credit cards for people with excellent credit. Not only will you get the funds you need, but also the zero percent interest may allow you to pay off the debt without ever paying any interest. To reap the biggest benefits two caveats apply. You must make large enough payments so that it’s paid off in a year and you must not put any additional charges on the card.
Qualifying for either a credit card or personal loan is dependent on your level of income and your credit score, to determine your ability to repay. Secure your financial future by preparing in advance for emergencies, such as sudden car repairs, by having a separate savings account set aside for that sole purpose. Compare terms and conditions of different offers before you make your final choice and sign an agreement.
About The Author: Vanessa May is a writer for www.wowcreditcards.com and a variety of other financial websites. Hoping to educate consumers, she uses government and other reputable sources to provide relevant news and information on money management, applying for credit cards, debt services, frugal living and other finance related topics. Her goal is to help consumers by providing useful knowledge that may impact their ability to manage their financial situation responsibly.