Personal Loan vs. Credit Card: Which is the Best Choice?
7 Min Read
Reviewed by Latoria Williams Covering daily expenses is challenging when you don’t have a planned budget for every situation. Whether you have to pay for utilities or make car payments, your savings may not be enough.
In this case, you wonder “what can I use: a personal loan or a credit card?” and the answer lies in the differences between these two loan products. Let’s discover them together!
Personal loans vs. credit cards: What’s the difference?
Both personal loans and credit cards are a functional way to cover expenses. But you must differentiate them to benefit correctly from their advantages.
A personal loan is a type of installment loan you receive in a lump sum but repay with fixed monthly payments plus interest. When you take out the loan, you’ll know exactly how long it will take to repay the funds and what is your monthly installment.
In contrast, a credit card is a type of revolving credit that comes with a credit line. You can spend only up to the credit limit of your card. Each month you’ll be required to make a minimum payment. But you’ll be on the hook for interest charges if you don’t pay off the balance in full each month. Also, you should know that a credit card debt doesn’t come with a set end date which can make you have an outstanding debt for several months.
Another feature of credit cards is their notoriously high interest rates. For example, Federal Reserve data showed that the average interest rate on credit cards is 20.09% in February 2024. The same study showed that the average interest rate attached to a 24-month personal loan was 11.48%.
When does using a personal loan make sense?
Personal loans present an attractive opportunity for covering a big expense. Borrowers with a steady income and a good credit score might be able to easily obtain a relatively low interest rate. With lower interest rates than most credit cards, many borrowers will find an affordable monthly payment option with a personal loan.
Beyond the lower interest rates, the set monthly payments tied to a personal loan make budgeting easier. Each month, the fixed payment will not change. Plus, you’ll know when this debt will be permanently out of your life.
Common personal loan uses
In general, a personal loan is a useful tool for a major purchase. A few of the common uses include:
- Large purchases: When you don’t have enough cash to cover significant expenses, consider a personal loan as a method to pay for home appliances or new car.
- Home improvements: Homeowners know that home improvements can get expensive quickly. Home equity loans are another option for homeowners with significant equity. However, the unsecured nature of personal loans comes with less risk of losing your home.
- Debt consolidation: You can use a single personal loan to consolidate debt. It can simplify your finances by eliminating multiple monthly payments. Plus, you can improve your credit situation. As a result, a good credit history will lock in a lower interest rate for future loans.
- Life events: Some life events come with celebration expenses. For example, you can fund your wedding festivities with a personal loan.
Pros and cons of a personal loan
Every financial product has advantages and disadvantages to consider. It’s important to weigh the advantages and disadvantages before moving forward.
Here’s a look at the advantages of a personal loan:
- Lower interest rates: Typically, personal loans have lower interest rates than credit cards, whose rates may reach 23.95%.
- Flexible use: You can use personal loans to pay for almost anything. For example, you might choose to consolidate credit card debt with a personal loan, pay for a wedding, or major home appliances.
- Range of credit accepted: Most borrowers, even those with bad credit, can find personal loan options. However, borrowers with a higher credit score can expect to find lower interest rates.
Now for the cons:
- Lump sum: The upfront lump sum might be a double-edged sword. If you need more funds down the line, you won’t be able to borrow more through this personal loan.
- No rewards: Some credit cards offer rewards for your spending. But personal loans don’t offer any rewards.
- Origination fees: Some personal loans come with original fees, which can take a bite out of your budget.
When can you use a credit card?
As a revolving credit model, credit cards help you cover smaller purchases that you make on an everyday basis. A credit card issuer sets you a credit limit that you must respect to avoid spending too much. Financial specialists recommend not spending more with your credit card than you are able to pay off each month.
Each month, you’ll have the chance to avoid interest charges by paying off your spending in full. If you spend more than you can afford, you’ll at least need to make the minimum payment to cover the balance. The remaining balance will rack up interest charges.
Common credit card uses
In general, credit cards are helpful spending tools for everyday purchases. Below are some common uses for a credit card:
- Basic spending: You might swipe your credit card at the grocery store or gas station to cover your expenses.
- Balance transfers: If you have credit card debt, you can often find a balance transfer credit card often offering an introductory 0% APY. This gives you freedom to pay off your credit card balance without incurring interest charges for a set term. If you choose this method, don’t forget to factor in the balance transfer fee.
- Unexpected expenses: You can use a credit card to cover daily unplanned costs you can’t pay with your savings account.
Pros and cons of a credit card
Like personal loans, credit cards come with advantages and disadvantages to consider.
Let’s explore the advantages of credit cards:
- Interest-free spending opportunity: If you pay off your credit card balance each month, you won’t pay interest on your spending. Of course, this strategy requires discipline. But it can help you avoid credit card debt while building a history of on-time payments on your credit report.
- Emergency spending: You can use your credit card to cover unplanned expenses. Whether it’s car repair or unexpected health issues, credit card is a fast way to pay for them.
- Rewards: Many credit cards offer rewards for your spending. For example, you might be able to earn travel rewards or cash back with every purchase. The right credit cards could stretch your dollars farther.
Now for the disadvantages of credit cards:
- Easy to overspend: For many, the ability to spend up to a credit limit comes with too much temptation. It’s easy to swipe your credit card too much and slide into debt.
- Minimum payment stretches out debt: If you only make the minimum payment, you could be stuck in debt for years.
- High interest rates: Credit cards tend to come with relatively high interest rates, which can be a drain on your finances.
- Annual fees: Some credit cards come with annual fees. Read the fine print before signing up.
Personal loan vs credit card: Which is right for you?
The right funding option depends on how you plan to use the funds. A personal loan might be best for a large one-time purchase. But a credit card is often a better choice for ongoing spending.
Also, be honest with yourself about money management. If you aren’t sure that you can reliably pay off a credit card balance each month, then the regular monthly payment tied to personal loans might suit your needs better.
Alternatives to a personal loan or a credit card
If you need access to funding, personal loans and credit cards aren’t your only options. Some other funding options include:
- Home equity loans
- Home equity lines of credit
- Personal lines of credit
- Cash advances
- Cash-out refinance
The bottom line
Personal loans and credit cards are two ways to fund your spending needs. Explore all of your options before applying for financing.
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