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You’ve decided that you need to borrow some money, but you don’t know exactly which type of loan will be best for your needs. Two of the most popular types of loans are personal loans and credit cards — but you don’t have to be a personal finance expert to know that they are both very different ways to borrow money.Let’s take a close look at personal loans vs. credit cards to help you find out which one is best for your needs.
What Is a Personal Loan?
A personal loan is a type of installment loan where the lender provides the borrower with a lump sum of money that they can use for a variety of purposes, such as making home improvements, covering car repairs or consolidating debt. You can also use a personal loan for emergencies.
Generally, personal loans are paid back each month in fixed payments, or installments, with interest. Repayment is typically spread over a period of two to seven years.
Personal loans can be either secured or unsecured. An unsecured personal loan is an installment loan that’s not secured by any property such as a home or vehicle, whereas a secured personal loan is backed by some type of collateral.
When to Choose a Personal Loan
A personal loan can be ideal for making large purchases. This simple type of loan allows you to break down a big purchase into smaller monthly payments that you spread out over time. A personal loan can also have lower interest rates than some other types of loans, including credit cards. Generally, interest rates are lower for secured vs. unsecured personal loans, though with the former you run the risk of losing your collateral.
Paying back a personal loan on time will add positive information to your credit history and can improve your credit score. However, if payment is not made promptly, your credit score can suffer.
One of the uses for a personal loan can be to consolidate your debts, especially those with high interest rates. And it’s also a great type of loan for people who would prefer to be committed to making the same payments each month. There are even personal loans available after bankruptcy.
Recommended: 10 Possible Benefits of Obtaining Personal Loans
What Is a Credit Card?
A credit card is a financial instrument that represents a revolving loan. When you use a credit card to pay for something, the credit card issuer (e.g., your bank) covers the cost of the purchase with the understanding that the cardholder will pay back the amount borrowed, plus any interest that applies.
When credit card users pay their entire statement balance in full by the statement due date, nearly all credit card issuers will waive interest charges. Credit cards represent an unsecured loan, so there’s no property that can be repossessed if credit card payments aren’t made. And while using a credit card irresponsibly can certainly damage your credit card, they can also help build it — in fact, there are a number of top credit building cards out there.
Credit card users also enjoy robust security protections against fraud and billing mistakes. They can also offer rewards in the form of cash back, points or miles. And finally, credit cards can provide travel insurance policies, purchase protection benefits and other perks.
When to Choose a Credit Card
Depending on your circumstances, a personal loan may not be the right choice. A credit card can be a good option when you need a secure and convenient method of payment and are confident you can pay off your balance in the short term to avoid paying interest.
As a revolving loan, a credit card has no set terms, other than the minimum payment amount you must make each month. With a credit card, you can borrow as much or as little as you need up to your approved credit limit, and you only pay interest on the loan based on your account’s average daily balance. Some credit cards can also come with 0% APR introductory financing offers for new accounts.
That means you won’t begin incurring interest on your charges until the day they are made, and you can make payments against your balance at any time, and in any amount. All you have to do is make sure that you make at least the minimum payment each month on or before the statement due date.
Pros & Cons of Credit Cards vs Personal Loans
When comparing a personal loan vs. credit cards, it’s important to consider the benefits and drawbacks of each.
|Credit Card Benefits||Credit Card Drawbacks|
|Revolving loan with flexible terms||Ease of use can make it easy to incur debt|
|Can be used for purchases at stores and online||Credit card interest rates can be higher than those of personal loans|
|Comes with robust protections against fraud and billing errors||Some credit cards have annual fees|
|Can offer valuable rewards and benefit||Will take a long time to pay off if you only make the minimum payment|
|Personal Loan Benefits||Personal Loan Drawbacks|
|APR can be lower than other loans||Personal loans can’t be used to directly make purchases|
|Can be used for a wide range of purposes, including large purchases||You’re locked into a fixed repayment schedule|
|Can make your debt easier to manage through consolidation||Can charge origination fees, and some have prepayment fees|
|Fixed rates and payments allow for more predictability and easier budgeting||Can lead you to rack up unnecessary debt.|
Credit Card or Personal Loan: Weighing Which One to Choose
Once you understand the advantages and drawbacks of each, it’s up to you to decide whether a personal loan or a credit card will best meet your needs.
A personal loan can be a better choice when you are making a large purchase and want fixed repayment terms. A credit card, on the other hand, can be a better option when you occasionally need to finance smaller purchases, or are just looking for a method of payment that can sometimes be used as a loan.
Alternative Funding Options
Even if you understand the difference between a credit card and personal loan, there are some other funding options that may be worth considering:
- HELOC: A home equity line of credit, or HELOC, uses the equity in your home to secure a revolving personal loan, allowing you to draw funds as you need them. Just keep in mind you are putting your home up as collateral, which means you could risk losing it if you fail to repay the loan.
- 401(k) loan: You can also take loans from your 401(k) retirement plan, which is essentially making a loan to yourself from your own savings. However, there can be substantial penalties if you fail to pay it back on-time or leave your employer with an unpaid loan. You’ll also be missing out on potential growth on those funds.
- Loans from friends and family: Friends and family can offer you personal loans. And while they may offer excellent terms without having to make a formal application, family loans can risk your relationships if not paid back.
Explore Personal Loan Options With Lantern
As you can see, there are clear differences between credit cards and personal loans, as well as pros and cons to consider when weighing whether a personal loan vs. a credit card is better for your financial situation. Make sure you understand the ins and outs of whichever financial product you choose, and that you can afford to pay off any debt you incur to avoid negative consequences to your credit score.
If you’re considering a personal loan, Lantern can help. We make it easy to compare rates and then apply for a personal loan in just minutes.
Photo credit: iStock/sefa ozel
About the Author
Jason SteeleJason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.