Credit Cards vs Personal Loans: Which is Better?
There are more forms of financing available than ever before. Apart from the cash you have at hand, you can use credit cards or personal loans to fill the gap in cash shortages. Many people use the credit card and treat it like a currency alternative to cash, while others also take personal loans to meet financial needs.
While it may be easy just to pick one and choose between a credit card and personal loan, there are several things to consider. First, both provide quick relief for financial shortages, but it also depends on how much need you, how soon you want to pay the debt and the interests, among other matters. However, the age old question remains, which one is better? Credit cards or personal loans?
The credit card is a type of revolving credit that you can avail from a bank or credit issuer. When you use the credit card, you also basically taking out a loan. You can use the credit card for most type of purchases, whether you are buying in person or online. It is also a widely accepted payment method even abroad.
Credit cards are typically unsecured which means you do not have to provide collateral to access and use them. The credit issuer generally evaluates your eligibility based on your financial history and creditworthiness.
How Credit Cards Work
Credit cards allow you to take out a short-term loan from your bank or credit issuer. When you use the credit card, the activity reflects on your credit report and is also reported to the credit bureaus. Over time, you also build your credit history.
Each month, you will receive your credit card statement stating your purchases and how much you need to pay. You generally have three options when it comes to payment. First, you may pay the full balance and wipe off the entire credit card debt. Paying the total balance allows you to avoid interests and other charges, so it was like borrowing money without interest.
You may also pay the minimum due amount stated on your bill. It’s a smaller amount than paying the full balance, but the remaining balance gets charged with interest. The credit issuer will keep charging interest as long as there is unpaid balance in your account. While it’s more manageable to pay the minimum due amount, the interest will keep you in debt for a longer period of time. Or you could also strike a balance between paying the full amount and the minimum due amount. You can throw a more substantial amount into the debt to minimize the total amount, but still, the remaining balance gets charged with interest.
Credit Card Pros
As a widely accepted payment method, the credit card gives you purchasing power with utmost speed and convenience. You can use it locally and internationally and allows you to purchase whether online or in person. You can use the credit card for basically anything, from food to groceries, paying bills, and significant expenses, like airline tickets, hotel accommodations, appliances, electronics, and jewelry.
2. Improve Credit Score
Many people use the credit card as a stepping stone in building and improving their credit history. If used wisely over time, your credit score can improve, which opens a host of other opportunities, such as getting another credit card, upgrading your credit line, obtaining loans from mainstream lenders, getting an apartment and upgrading your utility packages.
3. Finance Purchases
You can use the credit card to pay for a significant expense without interest in payments. A lot of credit issuers periodically rolls out zero percent introductory rates for at least six months. You can take advantage of this offer, make your purchases, and not incur any interest at all within this set time-frame. Such offers are also excellent options for people who want to consolidate their debts or perform balance transfers using the credit card.
4. Financial Relief During Emergency
Whether you have a hefty bill to pay or suddenly ran out of cash, you can use the credit card to see you through the rough financial patches. You can use the credit card to pay for basic needs like food and bills, or even take out a cash loan from it. It’s not always wise to use the credit card this way, but it does offer some relief should you run out of all the other options.
5. You are Protected
Credit cards offer several layers of security against fraudulent activities. Most credit card issuers are equipped to detect a potentially deceptive purchase should your credit card gets into the wrong hands. They can temporarily freeze your account and alert you should they see something fishy in your activities, such as purchases made abroad when you’re in the country. Additionally, credit card holders are eligible for refunds should they make a wrong purchase or want to return the item for defects. Such protection is not available for debit cards and ATM accounts.
Credit Card Cons
1. High Interest Rates
The credit card is a great financing tool given all its benefits, but everything can be wiped out if you’re not careful when it comes to payment. The credit card has a higher interest rate than other traditional financing options, and the debt can inflate if you leave a balance in your account for an extended period of time. Many people deal with credit card debt because they choose to pay only the minimum amount. It’s important to remember that you are always racking up debt as long as there’s a balance to pay.
2. Lower Credit
While it’s true that you can use the credit card to build credit, the same tool can also damage your credit. If you’re not careful about using your available credit and settling your payments on time, the credit score you worked so hard to build can take a plunge.
3. Tempts You to Overspend
Having a credit card on hand does make purchases easy, but perhaps too easy. It’s often easy to make a purchasing decision when you know that you have the credit card to cover for that cost for the meantime, but it doesn’t mean that you can afford such purchase when the time comes that you have to settle the bill. The credit card makes you believe that you can make a purchase right then and there, only to find out that it’s beyond your financial capacity to pay back.
A personal loan is a loan you take out from a bank, credit union, or third-party lender that doesn’t require collateral. This type of loan is called an unsecured personal loan. However, there are also personal loans that are secured or those that require collateral. In most cases, approval for unsecured personal loans depends on your credit standing and financial history and capacity. It has a higher interest rate than the secured ones, but not as much as a credit card charge. Secured personal loans also take into account your creditworthiness, but you can take a loan with a higher amount or with better interest rates depending on your collateral.
Unlike the credit card which is a form or revolving debt, the personal loan is an installment debt. The loan provider gives you the lump sum of the amount you applied to borrow, and then you pay it back in equal monthly installments. You can use it consolidate your debts, pay for a vacation, fund a business or finance home improvements.
How Personal Loans Work
A personal loan works pretty much the same way as a student loan or home loan work. First, you apply for the desired loan amount to the lender, and the lender will evaluate your qualifications and eligibility. The lender will work out the interest rate that applies to you based on your credit score, and if you agree, will release the loan to you. The lender will also set out a payment agreement, indicating the installment amount you need to pay each month and for how long the loan will take effect. You will keep paying the monthly due amount until you have fully paid the entire loan off.
Personal loans are available from your bank or credit union, but a lot of lenders today offer online personal loans application. With that said, you only need to visit the lender’s website, enter your information and submit the required documentation. The lender can then get back to you with an offer, indicating how much you can borrow, what the interest rate is and the loan term.
If the terms of the loan are amenable to you, the lender will send you a promissory note for you to sign. After which, the lender will deposit the loan amount into your bank account, and then you start paying off the loan beginning on the agreed date. You need to provide the payments each month, in full and in time to avoid late fees and charges.
Most personal loans are long-term, typically ranging from 2-5 years. However, you can find loan providers that offer personal loans for as short as one year, depending on the amount that you intend to borrow. The interest rates vary wildly as well, averaging from 5% to double digits.The interest rate depends on your creditworthiness. The higher your credit score, the better the chances of getting personal loans with the lowest interest rates.
Personal Loans Pros
1. Use for Personal Spending
Personal loans are a versatile type of loans that you can use for a variety of purposes. You can use it finance education, supplement business capital, finance home improvement, spend on vacation or special occasions and so on. You have the full liberty to spend the personal loan on whatever you deem fit.
2. Manageable Payment Structure
Personal loans are structured in such a way that payments are distributed equally for the entire loan term. Not only does it break down a massive loan into affordable payment installments, it also makes the loan so much more predictable. You know exactly how much you need to come up with each due date.
3. Better Interest Rates
Most personal loans interest rates hover on the single digit, averaging around 5% in APR. Credit cards are so much more expensive, with rates from 13% and above. If you’re looking to avail the lowest interest rate possible, work on your credit score first and strive to improve it.
4. You Have More Time to Pay it Off
It can be a burden to try to settle a huge loan in a short amount of time. With personal loans, you have a lot of time to come up with a payment with only one due date each month. Additionally, you can pick lengthier loan term to reduce the monthly installment further, or choose a shorter one to get over the loan relatively quickly. Other financing tools like payday loans require borrowers to settle their debt in two weeks, which when not met, forces them to roll the loan over and incur even more debt.
Personal Loans Cons
1. The Lender Can Seize Your Collateral
In the case of secured personal loans, lenders have the right to seize your collateral if you fail to meet your payment obligations. This runs the risk of getting your assets into jeopardy – you can potentially lose your car or home should you default on the loan.
2. Poor Payments Can Affect Your Credit
A lot of personal loan lenders nowadays report to credit bureaus, so it can be a great way to build credit as well. In the same way, misusing personal loans can lead to a poor credit score. The best way to protect your credit is to pay off your monthly obligations promptly and consistently.
Which one is better?
Choosing between a personal loan and a credit card can be a contentious issue to some. Both personal loans and credit cards have their own benefits and drawbacks, and it’s important to weigh your options carefully before making a decision.
To help you with the decision-making process, here are the things that you need to consider:
1. Loan amount – if you don’t need a huge amount, it may be better to opt for a
credit card with lesser interest, or better yet zero percent introductory rate. You can settle the debt much more quickly and even avoid interest if you pay it on time.
On the other hand, if you need a huge amount, say at least $5,000, then it’s better to opt for personal loans. You don’t have to settle the entire amount in one go, allowing you more leeway every month to come up with the installment you need. Additionally, you can pay off the loan in a few years so that payments don’t have to be as burdensome to you.
2. How long do you want to pay it back – a credit card gives you access to ongoing credit – that is, you can keep purchasing and paying your debt. Your balance inflates and deflates as you are buying and paying. While it is an ongoing debt, it is safe to assume that the debt should regarded as short-term. You must try to settle it in full and promptly to avoid incurring interests. Meanwhile, personal loans are fixed – you know exactly how much you need to pay each and for how long. It is a long-term debt that ends when you’ve settled the totality of the loan.
3. What is the interest rate – you cannot overlook the role of interest rate when deciding between personal loans and credit cards. Personal loans have a lower interest rate while credit cards’ interest rate hovers in the double-digit. Whether you are taking a personal loan or using a credit card, you must strive to nail one with the lowest rate to make debt less expensive.
There is no standard answer as to which is better: credit card or personal loans. It all depends on the situation and financial circumstances: different situation, different solution. It is best to exercise wise judgment and consider your options carefully. Remember that any decision you take can affect your financial life in the long-run.
Cary Silverman is a consummate entrepreneur having sold multiple companies during his 20 years of business experience in the financial industry, but for him, it isn’t about the money. His success is rooted in his passion to focus on doing something better today than it was done yesterday. These days, he’s the CEO of Waldo General, Inc. that oversees the operation of King of Kash.