Whether you’re planning a large purchase or simply need some extra cash, there are a number of funding options available. Two of the most common are personal loans and credit cards, but which one is right for your financial needs? When it comes to choosing the right one for your situation, factors like interest rates, repayment terms, credit score impact, and how you plan to use the funds can all play a major role.
The Personal Loan Basics
A personal loan offers a lump sum of money that you repay with fixed monthly payments over time. This type of debt is referred to as installment debt, and you’ll know in advance how long you’ll need to make payments until the debt is cleared.
Personal loans have a term that varies from several months to five or even seven years. You can use the funds for practically any purpose. So, whether you want to make a major purchase, pay for a vacation, consolidate credit card debt or make home upgrades, a personal loan can be a good option as they typically have lower interest rates, particularly if you have good or excellent credit.
Typically, personal loans are unsecured, which means that you don’t need to provide any collateral. The lender issues the loan based purely on your credit history and financial situation. However, some lenders do offer secured personal loans, which can be a viable option if you have less than ideal credit. You would need to offer up your home, vehicle or other asset as collateral, and this item would be put at risk if you fail to stick to the repayment schedule.
Pros
- Usually lower interest rate borrowing, compared to credit cards
- Offers predictable fixed monthly payments
- Can be used for practically any purpose
Cons
- May attract origination of other fees
- Does not offer rewards
- Does not provide additional funding after you receive the lump sum
The Credit Card Basics
Credit cards are revolving credit, which provides ongoing access to funds to draw on as needed. Unlike receiving a lump sum with a personal loan, you’ll have an agreed credit limit and you can charge purchases to your card account up to that limit. Each time a charge is added to your account, your available credit will reduce and when you make a payment, it will go back up. This has the potential to go on continually, hence why it is called revolving credit.
While you may have a credit limit equal to a personal loan amount, you will only pay interest on the funds that you use. Additionally, most credit cards have a grace period, so when you make a charge to your account if you pay the subsequent bill in full, you won’t incur any interest on your account. Some credit cards also have introductory offers, where you can get a zero or low APR for six, 12 or even 24 months. This can be a good way to finance a large purchase or pay down a credit card balance, paying little or no interest.
| Credit Card Type | Best For | Key Features | Considerations |
|---|---|---|---|
| Rewards Credit Card | Everyday purchases | Earn points, miles, or cashback on spending | May have higher APRs or annual fees |
| Balance Transfer Card | Paying off existing debt | Introductory 0% APR on balance transfers (usually 12–21 months) | Transfer fees may apply |
| Low-Interest Card | Large purchases or carried balances | Low ongoing APR for purchases and balance transfers | May lack rewards or perks |
| Secured Credit Card | Building or rebuilding credit | Requires a refundable security deposit; reports to credit bureaus | Low credit limit; few rewards |
However, this flexibility does mean that you won’t have set repayments each month. Your credit card issuer will send a bill every month, which shows the current balance and a minimum amount due. This is calculated according to your current balance and interest charges. As we just discussed, if you pay the bill in full, no additional interest will be added to the account. On the other hand, if you only pay the minimum amount due, you will only pay a little off the outstanding balance, since the remainder of the payment will cover the interest charges. This means that your debt will continue to grow, which can make it challenging to clear later.
Some credit cards also offer rewards for spending. You could earn points, miles or even cash back, particularly if you spend in certain categories such as travel, groceries or gas. You may even get additional perks such as free subscriptions, free insurance, and even travel perks such as free checked bags or lounge access. However, the cards with the most comprehensive benefits tend to have a higher annual fee. This amount is added to your card balance each year, regardless of whether you’ve used the card or are carrying a balance.
Pros
- Ongoing credit line
- Only incurs interest charges on the amount you use
- If you pay your bill in full, you’ll not pay interest
- May offer additional benefits such as introductory interest rates, rewards and perks
Cons
- Interest is typically higher compared to personal loans, even if you have excellent credit
- Fees and interest charges can add up, creating a debt cycle
- May have an annual fee, which is charged regardless of if you use the card.
The Similarities of Personal Loans and Credit Cards
While there are some important differences between a personal loan and credit card, there are some similarities.
The Application Decision
Whether you qualify for a personal loan or credit card will mainly depend on your current financial situation and creditworthiness. You will need to demonstrate a history of responsibly managing debt and have an ability to pay back borrowed funds in the future. The lender or card issuer will use your credit score and other factors including your debt to income ratio to determine this.
With either product, the better your credit and financial situation, the more options you are likely to have. Those with excellent credit are more likely to find lower rates and other benefits such as credit card perks, while if you have poor credit, you will have limited options for either product.
Unsecured Debt
Both credit cards and personal loans are unsecured debt. You can use the funds for almost any purpose, but if you need cash, you may incur a cash advance fee if you use your credit card. Since the debt is unsecured you won’t need to provide a home or car as collateral, but if you don’t make your payments as agreed, you will damage your credit score.
The Impact on Your Credit Score
Any form of borrowing has the potential to affect your credit score. When you apply, the lender or credit card issuer will initiate a hard inquiry, which usually causes a drop of a few points on your credit score. However, when you make payments on time, it can help to boost your score.
If you want to improve your credit score, making credit card payments can be a quicker route, as it can improve your credit utilization ratio. This is a measure of how much debt you have as a percentage of your total credit. So, if you have combined balances of $10,000 with total credit limits of $20,000, your credit utilization is 50%.
When you have a personal loan, that account balance will gradually decrease over time. However, you can choose to use little or none of your credit card limit, which improves credit utilization.
When to Consider a Personal Loan
There are a number of scenarios where a personal loan can be a good fit.
You Want Consistent, Predictable Payments
With a personal loan, you will know exactly how much you will need to pay each month and when the balance will clear. This means that you can set an end date in mind for when you will have repaid the debt. These set repayment terms provide predictability and consistency for planning your monthly finances.
You Want the Lowest Borrowing Rates
If you need to finance a one time expense at the lowest borrowing rate, a personal loan tends to be the better option. The APR on personal loans is typically far lower than the average credit card rates.
You Need a Large Amount
If you’re planning a big project such as a home renovation, a personal loan is likely to offer access to a larger amount of funding. Credit card issuers typically limit purchases to a maximum of $10,000, while you can borrow as much as $100,000 on a personal loan.
You’re Concerned About Spending Habits
A credit card can provide ongoing access to credit, so it is easy to swipe purchases without even thinking about the consequences. If you use up the personal loan funds, you will need to apply for more money, so you can’t inadvertently overspend.
When To Consider Credit Cards
On the other hand, there are a number of scenarios, where a credit card can be a better fit for your needs.
You Want to Finance Smaller Purchases
Credit cards work well for regular spending that you can quickly repay, particularly if you get rewards for regular spending. You can even set up auto payment for small recurring bills, so you can just make one payment each month to clear your credit card bill.
You Want to Limit Interest Charges
If you want to make a large purchase or consolidate debt and want to limit the amount of interest you pay, a credit card could work for you. If you pay the bill in full when it arrives, you’ll pay no interest on the charges. However, you may qualify for a card with a 0% APR rate for a set period. This means that you can spread the costs and not incur any interest charges.
You Want to Earn Rewards
There are no additional incentives associated with personal loans, but there are many credit cards on the market that offer points, miles or cashback for your everyday spending. You can even strategically plan your purchases to maximize the rewards. However, you do need to watch out for hefty annual fees that could negate the rewards or card perks.
Which is Best for Debt Consolidation?
If you currently have credit card or other types of debt and want to consolidate to make it easier to pay down what you owe, you can use a personal loan or a credit card. In either scenario, you will need to focus on repaying your debt and stop accruing more debt.
A personal loan can be a good option if you have a large amount of debt and will need significant time to pay it off. You can get a lower rate compared to your existing debt and have a schedule of fixed monthly payments to steadily pay down the debt.
If you have a small enough amount of debt to be able to clear it in 12 to 18 months, a balance transfer card with a 0% APR introductory rate could work well. You can transfer the balance from your other credit cards and pay back the debt each month within the promotional period. Just be sure to plan to repay the entire balance before the end of the promotional period or you’ll start to incur hefty interest charges. Additionally, you need to check the fine print in the credit card terms and conditions to ensure there are little or no balance transfer fees. These can be as much as 5%, which may seem insignificant, but with a debt of $5,000, you’ll pay a $250 charge.
Other Types of Consumer Credit
While personal loans and credit cards are some of the most popular ways to access credit, there are some alternatives that may be a more appropriate choice for you.
Auto Loans
If you’re planning on buying a vehicle, an auto loan is similar to a personal loan, but it is secured on the vehicle itself. Since the lender has the security and the ability to repossess the vehicle if you fail to make the scheduled payments, you can access lower rates and more beneficial terms.
Typically, auto loans have a term of five to seven years, but you can often lock in a fixed rate. This means that you will know exactly what the loan will cost you each month and you’ll have an end date for your repayments.
Home Equity Loans or Home Equity Lines of Credit
If you own a home and have sufficient accumulated equity, you could be eligible for a home equity loan or HELOC. The former offers a lump sum, like you would get with a personal loan, while the latter offers a line of credit that you can draw on as you need funds up to an agreed limit. Both these products are secured on your home, so you can access lower interest rates and longer term borrowing. However, your home is at risk if you fail to make the scheduled repayments.
Personal Lines of Credit
This is a form of revolving credit that is a little like a credit card. You can access funds at any time up to an agreed limit.
Payday Alternative Loans
Payday loans traditionally were short term, small loans with a very high interest rate. This product was considered predatory lending, since the interest charges were many times the rates of alternative credit products. For this reason, payday loans were outlawed in several states. However, some financial institutions now offer payday alternative loans or PALs. These are typically offered for small amounts up to $1,000, but have far more reasonable rates.
FAQs
How Much Would a $10,000 Personal Loan Cost Each Month?
There is no easy answer to this question as it would depend on the loan term and the interest rate. There are online calculators that can provide an estimate of monthly costs and lenders should provide you with a quote when you make an inquiry.
Does It Hurt Credit to Get a Personal Loan?
Any new credit product will cause a slight dip in credit scores, since the lender will initiate a hard credit inquiry. However, once you have the loan and make the payments on time every month, it can actually help to boost your credit score, since you’ll have a positive credit history.
Why Was My Application Declined?
There are no guarantees that your application for a personal loan or credit card will be approved. Each lender or card issuer has its own qualification requirements, so if your application was denied, it could be due to your credit score being too low, insufficient income, carrying too much debt or other factors. For this reason, it is usually a good idea to check for pre-approval before you submit a full application. This will let you know if you’re likely to be approved without impacting your credit.
Choosing between a credit card or personal loan can seem a little daunting, but remember that everyone’s circumstances, requirements and preferences are unique. So, you need to take a little time to think about what you are looking for and why you need the credit. If you have a clear purchase or financial goal in mind, it will help you to decide which type of product is best suited to your needs.
Whether you want to make a major purchase, or consolidate your debt, either a personal loan or credit card could work for you. What you need to decide is whether you’re the type of person that likes the structure of fixed monthly repayments or would prefer to access additional perks and rewards.
Remember that your credit score will influence the availability of financial products, so you will need to compare the rates, terms and other features of products that apply to your credit profile to make an informed decision.
