Personal loans and credit cards require you to borrow money that must be paid back, but the way they’re set up and the perks they offer work better for some than for others. Read on to find out which might work better for your goals.
There are times when you just have to borrow money to stay afloat or to pay for a long-term goal you can’t seem to save for.
Not only that, but life happens and other bills never seem to stop rolling in. For that reason and plenty of others, it’s not uncommon for consumers to borrow money via a credit card or even a personal loan.
But, which option is better? That really depends on your goals and who you ask. Both personal loans and credit cards require you to borrow money that must be paid back, but the way they’re set up and the perks they offer work better for some than for others.
How do personal loans work?
Personal loans have become all the rage these days, mostly due to obsessive marketing efforts from the online lenders and banks that offer them.
Still, these loans can be better than other options if you need to borrow money. Not only do personal loans come with fixed interest rates and fixed repayment periods, but they also come with a fixed monthly payment that will never change.
How do personal loans work in real life? With a loan from a lender like SoFi, for example, you can borrow up to $100,000 with a fixed monthly payment, a fixed repayment timeline and a fixed APR between 5.99% and 21.20% with autopay.
If you wanted to take out a personal loan to consolidate $10,000 in credit card debt and you had excellent credit, you might consolidate that debt onto a new personal loan with a 5.99 percent APR. In that case, you might choose a personal loan with a five-year term and a monthly payment of $193 during that time.
With this example, you would know exactly how much you would pay each month ($193) and exactly how long you would pay it (60 months). Your interest rate would also never change, which makes personal loans downright predictable.
See related: How credit scores affect interest rates
How are they different from credit cards?
Still, there are other reasons personal loans really stand out apart from credit cards. According to financial coach Steven Donovan, the fact that money is more about psychology than your financial knowledge can work in your favor. That’s because you get personal loan funds in a lump sum, and you can’t keep using it over and over to borrow more like you can with plastic.
“A personal loan will limit the consumer’s chances of getting into more debt since the personal loan is not a revolving loan like a credit card,” he says.
Not only do credit cards come with a variable interest rate, but the fact that they’re a revolving line of credit and you can continue using them for purchases means that your monthly payment can change, too.
College professor and financial planner Brandon Renfro says another benefit of personal loans is the fixed repayment term that helps consumers know exactly when they’ll be debt-free, and that this is also a major downside of credit cards.
“With a credit card you could cut back to paying only the minimum,” he said. “That could help you in a pinch, but you’d want to get back to a point where you could pay more than the minimum quickly.”
A final benefit of personal loans over credit cards is that, if you have good credit, you can typically qualify for a much lower interest rate. Where the average APR for credit cards is currently around 16%, you can frequently find personal loans with APRs as low as 5.99%.
When is a credit card better?
While credit cards come with higher variable APRs, they offer more flexibility and a handful of benefits that can make them a good deal. For starters, credit cards let you borrow only what you need, meaning they don’t require that you commit to borrowing a lump sum.
According to author and financial attorney Leslie Tayne, this is why credit cards are often the better choice when you need to make smaller purchases and pay them off relatively quickly. When you have the opportunity to charge purchases as you go, you may wind up borrowing less.
Many consumers also use their credit cards for their everyday purchases to earn rewards. This strategy can leave you ahead each month if you consistently pay off your balance in full. Some credit cards even offer big sign-up bonuses if you can spend $500 or more within three months, which is easy to do with just regular spending and bills.
“This can be a good system if you’re making a consistent habit of paying your balance off completely,” she says.
Tayne noted that credit cards can also come with additional security like extended warranties and purchase protection, which can help protect your investment when you buy items that qualify for this coverage.
Some cards also offer lower initial rates that can make applying for a card worth it when compared to the rate you might get on a personal loan, says Renfro. He’s talking about cards that offer a 0% APR for anywhere from 12 to 18 months on purchases or balance transfers.
With a card that gives you 0% APR on purchases for a year or more, you could potentially borrow the money you need to make a large purchase, then slowly pay it off without interest over time.
Just remember that, like all good things, 0% APR offers come to an end. If you don’t pay your balances off before your introductory offer is up, you’ll watch as your interest rate resets to a much higher variable APR.
And either way, it’s important to beware of the pitfalls of using credit, the biggest of which is the potential to rack up debt you can’t just pay off. It’s tempting to spend with credit when you won’t get the bill for several weeks, but carrying a balance can leave you paying a high APR with very little in rewards to show for it.
See related: 8 things you must know about credit card debt
When is a personal loan better?
For the most part, experts agree that personal loans are best for people who may need more time to pay down their balances. You’ll get a low fixed rate that can last for several years – and the security of a fixed monthly payment that will never change.
Not only that, but personal loans themselves can’t be carried around in your wallet and used to rack up more debt. With that in mind, a personal loan can be a better choice if you need to borrow a specific amount of money, but you’re worried a credit card might just entice you to spend more.
Whether you’re leaning toward a credit card or a personal loan, just remember that the same pitfalls apply. You can borrow more money than you need with either product, and both can lead to major damage to your credit score if you stop making payments for any reason.
Your best bet is thinking long and hard about how much you want to borrow, how much time you need to pay it off, and the monthly payment you can afford before you pull the trigger on any loan. Then and only then can you borrow money with minimal risk of your new debt inflicting harm on your other financial goals.
But borrowing still has its problems, even if you have a plan. Pitfalls to watch out for can include letting banks drive your purchasing decisions, and that’s especially true if you are prone to listening to their marketing spiels.
“Banks are in the business of making money,” says Donovan.
That’s why you should always sit down and do your own research, look at your spending plan and make the decision that fits your income.
Also, be sure you wind up with a monthly payment that doesn’t stretch your finances too far. In other words, leave plenty of wiggle room in your budget even after accounting for repayment of your new debt.
Finally, don’t forget that money lost to interest payments is basically set on fire. You’ll get nothing in return for the cash you pay toward interest and fees when you take out a loan or use a credit card, yet you stand to lose a lot.
Only you can decide if borrowing is worth it, whether you need a loan for debt consolidation, home repairs or a luxury vacation to the Maldives. Just remember that debt doesn’t go away on its own. Once you invite debt into your life, you’re stuck dealing with it until you eventually pay it off.