Credit cards and personal loans: comparison of options

Avoiding debt is a noble goal, but not always achievable.

There are times when you just need to borrow money to stay afloat or pay for a long-term goal that you’re struggling to save money for.

Not only that, but life happens – and the other bills never seem to stop coming in. For these and many other reasons, it is not uncommon for consumers to borrow money with a credit card or even a personal loan.

But which option is better? It really depends on your goals and who you ask. Both personal loans and credit cards require you to borrow money that you must repay, but the way they are set up and the benefits they offer work better for some than others.

The biggest difference between a personal loan and a credit card

Personal loans have become all the rage these days, largely due to intrusive marketing efforts from online lenders and the banks that offer them. In short, the main difference between them and credit cards is that you get the loan funds in a lump sum, so you can’t use personal credit over and over again to borrow more than you can with plastic.

However, these loans may be better than other options if you need to borrow money. Not only do consumer loans come with fixed interest rates and fixed repayment periods, they also come with a fixed monthly payment that will never change. Keep reading to find out how personal loans work. Then learn how personal loans differ from credit cards:

How do consumer loans work?

How do consumer loans work in real life? For example, with a loan from a lender like SoFi, you can borrow up to $100,000 with a fixed monthly payment, a fixed repayment schedule, and a fixed annual interest rate of 5.99% to 21.20% with auto payment.

If you wanted to take out a personal loan to consolidate your $10,000 credit card debt and you had an excellent credit history, you can consolidate that debt into a new personal loan with an annual interest rate of 5.99%. In this case, you can opt for a personal loan for five years and a monthly payment of $193 during that time.

In this example, you would know exactly how much you would pay each month ($193) and for how long you would pay (60 months). Your interest rate will also never change, meaning that a personal loan is completely predictable.

Personal credit can limit the amount of debt you get into

According to financial coach Stephen Donovan, the fact that money has more to do with psychology than your financial knowledge can play into your hands if you take out a personal loan. “Personal credit will limit the consumer’s chances of getting into debt because personal credit is not a revolving loan like a credit card,” he says.

Not only do credit cards have variable interest rates, but the fact that they are a revolving line of credit and you can continue to use them for purchases means your monthly payment can change as well.

A personal loan will give you a fixed repayment schedule

College professor and financial planner Brandon Renfro says that another benefit of personal loans is the fixed repayment period, which helps consumers know exactly when they will be debt-free, and that this is also a major disadvantage of credit cards.

“With a credit card, you can cut costs to a minimum,” he said. “It might help you in a pinch, but you’d like to go back to where you could quickly pay more than the minimum.”

If you have good credit, you can qualify for a much lower interest rate

The final difference between personal loans and credit cards is that if you have good credit, you can usually qualify for a much lower interest rate. While the average annual interest rate on credit cards is currently around 16%, you can often find personal loans with an annual interest rate as low as 5.99%.

When should you use a personal loan?

For the most part, experts agree that personal loans are best for people who may need more time to pay off their balances. You will receive a low fixed rate that can last for several years and a guaranteed fixed monthly payment that will never change.

Another plus is that you can’t carry around a personal loan in your wallet and use it to build up debt. With that in mind, a personal loan may be the best choice if you need to borrow a certain amount of money but are worried that using a credit card might encourage you to spend more.

When to Use a Credit Card

While credit cards have higher APR variables, they offer more flexibility and a range of benefits that can make them worthwhile. First, credit cards allow you to borrow only what you need, meaning they don’t require you to commit to borrowing a lump sum.

According to author and financial lawyer Leslie Thain, this is why credit cards are often the best choice when you need to make small purchases and pay relatively quickly. When you have the ability to charge for purchases as you go, you can borrow less. Here are some other times you can use a credit card instead of a personal loan:

Use your card to earn rewards

Many consumers also use their credit cards for everyday purchases to earn rewards. This strategy can keep you ahead every month if you consistently pay off your balance in full. Some credit cards even offer great signup bonuses if you spend $500 or more over a certain number of months, which is easy to do with regular expenses and bills.

“This can be a good system if you have a consistent habit of paying off your balance in full,” Thane says.

She also noted that credit cards can provide additional security, such as extended warranties and purchase protection, which can help protect your investment when purchasing covered items.

Use a card with a great initial APR offer

Some cards also offer lower starting rates, Renfro said, which may justify applying for one of them compared to the rate you might get on a personal loan. He talks about cards with 0% APR offers for 12 to 18 months for purchases or balance transfers.

With a card that gives you 0% APR on purchases for a year or more, you can potentially borrow the money you need to make a big purchase and then pay it back gradually without interest over time.

Just remember that like all good things, 0% APR offers come to an end. If you don’t pay off your balances before your introductory offer expires, you’ll see your interest rate reset to a much higher variable annual interest rate.

In any case, it’s important to beware of the pitfalls of using credit, the biggest of which is the possibility of accumulating debt that you can’t just pay off. It’s tempting to spend with a loan when you don’t receive a bill in a few weeks, but having a balance can result in you paying a high annual interest rate with very little reward for it.

bottom line

Whether you’re leaning towards a credit card or a personal loan, just remember that the same pitfalls apply. You can borrow more money than you need with any product, and both can seriously damage your credit if you stop making payments for any reason.

Think carefully about how much you want to borrow, how long you need to pay it off, and the monthly payment you can afford before taking out any kind of loan or line of credit. Then, and only then, can you borrow money with minimal risk that your new debt will harm your other financial goals. Also, leave plenty of wiggle room in your budget even after factoring in the repayment of your new debt—remember, life happens.