Unexpected expenses happen to the best of us: The car needs a new transmission, the roof leaks, or someone in the household needs costly medical treatment. If you don’t have an emergency fund set aside for such events, getting a loan or putting it on your credit card are sometimes the next best options.
Credit cards and personal loans have several common characteristics, but they aren’t exactly the same. Knowing the best times to use each can help ensure you’re using your money in the smartest way possible.
When to put it on your credit card
Credit cards are a form of credit, sort of like small loans taken out at the time of purchase. You’re given a dollar limit and are required to make monthly payments. The minimum payment required may fluctuate, as can the interest rate, depending on the card.
So, when does it make sense to put expenses on a credit card? When you can pay them off quickly. This is especially true if you can take advantage of a 0% credit card offer.
Interest-free credit cards allow you to avoid interest for an introductory period generally lasting 12 to 18 months. If your anticipated expense doesn’t amount to more than 30% of your credit limit (which can hurt your credit score) and can be paid off during this interest-free period, using a credit card could be your best option.
When a loan makes more sense
Personal loans are lump sums of money that you borrow from the bank or credit union. Normally, they are unsecured, meaning you don’t have to put up collateral. The interest rate on a personal loan varies, depending on your credit score. Once you have your rate your monthly payments are fixed so you know how much you need to pay each month.
Taking out a personal loan makes sense when you don’t anticipate paying off the debt all at once and you don’t have access to an interest-free credit card, as the interest rates on personal loans are generally lower than those on credit cards.
Loans are also most appropriate for larger expenses. Major home improvements and medical procedures are just a few examples.
If you’re leaning toward a loan, don’t forget about origination fees. Many lenders charge a fee for taking out the loan, normally between 1% and 5% of the total amount of the loan, depending on your credit. Depending on the amount you’re borrowing, this could end up being a considerable addition.
Whatever your choice, play it safe
Whether you choose to charge it or borrow the money from a bank, make sure you have a plan for paying off your debt. You don’t want to stretch yourself too thin and wind up struggling to make monthly payments. Don’t just choose the option that best meets your current need for money, but the option that speaks to your future ability to pay.
Image via iStock.