The basic difference between personal loans and credit cards is that personal loans provide a lump sum of money that you pay back each month until your balance reaches zero, while credit cards give you a line of credit and a revolving balance based on your spending.
Deciding when to use a personal loan versus a credit card is a little more nuanced. How much money you need and how quickly you can pay the money back are key factors in deciding which to use.
When to use a personal loan
A personal loan is a good option when you:
- Qualify for a low interest rate per annum. Low-rate loans can make monthly payments more affordable and reduce your principal more quickly.
- Want to consolidate large, high-interest debts. High borrowing amounts and fixed payments over a few years can help you pay down debts.
- Need to finance a large, one-time expense. Ideally, the expense will help your finances in the end, like a home improvement project. Personal loans aren’t designed to be taken out frequently.
- Can make monthly payments over the loan term. As with credit cards, missing payments or consistently paying past the due date results in a hit to your credit score.
Annual interest rates on fixed-rate personal loans generally range from 7% to 20% . Borrowers with a very good or excellent credit score may qualify for a rate at the low end of that range. Borrowing limits can also be high, up to $75,000 for the most qualified borrowers.
A personal loan is an instalment loan, which means you get money all at once and make fixed monthly payments over a set period, usually one to seven years. Some lenders allow you to make additional payments to pay down the balance quicker. Many online lenders let you pre-qualify for a loan to see estimated rates, with no impact on your credit score.
Personal loan pros
- Typically have lower interest rates than credit cards on average.
- Fixed monthly payments can help keep your budget on track.
- Loan lenders that provide fast funding can get you a large sum of money quickly.
Personal loan cons
- Monthly payment amounts and schedules may be hard to adjust.
- You get a fixed amount of money, not a credit line to draw from.
» MORE: Personal loan vs. car loan
When to use a credit card
Credit cards are a good option when you:
- Need to finance smaller expenses. Credit cards are good for regular spending that you can repay quickly, especially if your card comes with rewards for regular purchases like groceries.
- Can pay off your balance in full each month. NerdWallet recommends repaying your balance in full each month so you’re never charged interest.
- Qualify for a 0% interest-free period. The cheapest way to pay for anything is without interest, so look for lenders with promotional offers.
Credit cards can be an expensive form of financing if you don’t pay off the balance each month or qualify for a card with a 0% interest-free period. Credit cards typically have double-digit interest rates, and carrying a high balance can negatively impact your credit score.
A credit card is a revolving form of credit that allows repeated access to funds. Instead of getting a lump sum of cash, you can charge up to a certain limit on the credit card. Minimum monthly repayment amounts are usually about 2% of your balance.
With higher rates and the risks of carrying a high balance, credit cards are best reserved for short-term financing and purchases you can pay off in full, like daily expenses and monthly bills.
Credit card pros
- Use it whenever you need it.
- Interest-free purchases if you pay in full each month.
- Good- and excellent-credit cardholders may have access to rewards.
- Some cards offer 0% interest-free promotional periods (usually 12 to 18 months).
Credit card cons
- Higher annual interest rates can make credit cards an expensive way to pay for things.
- Some cards come with annual fees.
- Not all credit cards are accepted by all establishments, and some charge a small fee to process credit cards.
Getting your first credit card? Whether you’re a beginner or a credit card pro, make sure you know how to handle a credit card responsibly. It’ll save you time, money and frustration.
How personal loans and credit cards are similar
Getting an unsecured loan or credit card depends mostly on your creditworthiness and finances.
Lenders want to see if you have a history of paying back borrowed money and an ability to do so in the future. They use your credit score to help measure that.
For both personal loans and credit cards, the better qualified you are, the more options you’re likely to have. Lenders offer low rates and consumer-friendly features to borrowers with good and excellent credit, so you can compare to see which offers you the best loan. Rewards cards are also reserved for borrowers with high credit scores.
Personal loans and credit cards are most often unsecured. You can use them to pay for almost anything you want.
Because you’re not securing the loan with property, like a house or car, your credit will take the hit if you don’t make on-time payments on the loan or card.
How credit affects your credit
Expect a hard credit pull when you apply for almost any type of credit. This usually causes a temporary drop of a few points.
Personal loan payments usually affect your credit less than credit card payments do
That’s because personal loans have fixed monthly payments that you agree to when you take the loan. Under normal conditions, you don’t have the option to pay a lesser amount. In making on-time payments, you’re doing what you said you’d do.
With a credit card, though, you choose whether you’ll pay the balance in full. Making that choice each month is a good indicator of creditworthiness and has a bigger impact on your score.
So while on-time payments toward each will positively affect your score, making your credit card payments could boost your credit score more quickly.
Personal loans vs. credit cards for debt consolidation
You can use a debt consolidation loan or a 0% interest rate balance transfer card to pay down debts. Your circumstances will help you determine which is right.
In both cases, you should be ready to stop accruing debt and focus on repaying it.
When to choose a personal loan
If you have a large amount of debt and need more time to pay it off, a debt consolidation loan can keep you on track to steadily pay down your debt. A loan is a good option if you can get a lower rate on the loan than what you pay on your existing debt.
When to choose a balance transfer credit card
If your debt is small enough that you could repay it within a year or so and you have good credit, try a balance transfer card with an interest-free introductory period.
These cards can help you pay the debt back, interest-free, as long as you repay it within the promotional period, typically 12 to 36 months.
Have a plan to pay off the entire balance before the 0% interest rate period expires; otherwise, you’ll get hit with double-digit interest rates on your remaining balance.
The savings you net through consolidation should also outweigh balance transfer fees, which are roughly 1% of the balance, and annual fees.
If you’re in the United States, read this article on the NerdWallet US site.