How to Choose Between a Personal Loan and a Credit Card

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If unexpected expenses have the potential to derail your finances, you’re not alone. According to a study by the Federal Reserve, only 63% of adults said they have the funds to pay for an unplanned $400 expense without going into debt. The rest—more than two out of three Americans—would have to put that expense on a credit card they could not pay off in the next billing cycle, or would have to borrow money another way.  

And that’s from a survey carried out in 2019, before the pandemic wreaked havoc on the economy.     

If you are in a similar situation — either you don’t have enough in savings to cover your financial emergency, or you don’t want to touch the money in that account — two options to consider when you have a large expense to cover are a personal loan or a credit card. A personal loan can also be a good idea when you want to consolidate debt into a single payment, with lower interest. 

There are key differences between the two, as well as pros and cons to each choice.

When to Use a Personal Loan

A personal loan can be obtained from a local bank or credit union, or from an online lender.

The funds can be used to pay for nearly anything, although experts caution against unnecessary borrowing.

“Personal loans are commonly used for debt consolidation, which is combining multiple payments, such as medical bills or credit card balances, into a single monthly payment,” says Amy Vos, a financial advisor at Northwestern Mutual. “Other common ways to use a personal loan include vehicle financing, small-business funding, and home improvements.”

But a personal loan can come in handy in a variety of other scenarios. 

For example, it can be used for an unexpected breakdown – your home needs a new roof, your car needs a new engine, or you have a medical emergency that insurance doesn’t cover. A personal loan can also be used to pay tuition if you don’t qualify for a student loan or if there’s a delay in receiving the funds.

Pros and Cons of a Personal Loan

The Upsides

There are several advantages to getting a personal loan. For example, if you’re consolidating your debts, you no longer have to keep up with several different due dates. 

“Combining multiple payments into a single monthly payment both simplifies and organizes your finances,” says Vos. However, this only makes sense if the interest rate on your personal loan is lower than the interest rate on your current debt. 

Because personal loans are repaid in fixed, regular installments, they can bring consistency, which is important if you’re trying to manage a budget. 

“Unlike a credit card, the payment is the same rate every time,” Vos says.

You might end up paying less overall, too. “Personal loans could possibly have lower interest rates than you’d find with many credit cards, but also have a higher borrowing limit,” says Leslie Tayne, founder and head attorney at Tayne Law Group, a law firm that specializes in helping people get out of debt. So, if you transfer balances from high-interest credit cards to a low-interest loan, you could save thousands of dollars, depending on the loan amount.

In addition, if you have good enough credit you can get an unsecured personal loan, meaning one that comes without the need to provide collateral, like your car or another valuable asset. 

The Downsides

However, there are also drawbacks to getting a personal loan. If you don’t have good credit, it will be hard to qualify for a personal loan with a low interest rate, Tayne warns. The interest on a personal loan if you have poor credit can be as high as a high-interest credit card.

“There are also fees to consider with personal loans, such as origination fees that go toward processing, and repayment penalties that are charged if the loan balance is paid off early,” Tayne says. (Not all personal loans have fees for early repayment.)

You might also have higher monthly payments than with a credit card, since the loan typically needs to be paid off in a relatively short time, from one to five years. 

When to Use a Credit Card

Credit cards are perhaps the most popular form of debt in America. In 2020, there were 497 million credit card accounts in the U.S., according to Experian

The consumer credit reporting company also noted that the average credit card limit in 2020 was $30,365, and the average credit card balance was $5,315.   

Credit cards can be used to pay for almost anything. They can be substituted in pretty much any scenario in which a personal loan would apply.

Pro Tip

Credit cards with a 0% APR introductory period are in essence a loan without interest, but you’ll need decent credit to be approved for one — and a plan to pay it back before the intro period expires.

Pros and Cons of Credit Cards

 The Upsides

When time is critical, a credit card application can lead to being approved for a credit line much faster than getting a personal loan. “It’s an incredibly quick approval process,” says Justin Goldman, co-founder and CEO at RenoFi in Philadelphia. You cannot know beforehand what credit limit a new card will have, although applicants with better credit scores will generally be approved for higher limits. 

That fast approval, which can put in your hands within days the ability to spend thousands without actually paying until later, can be dangerously tempting — and credit card balances may have high interest rates, too. “If you plan to pay it off quickly, the high interest rate may not be a big deal over the short term,” Goldman says. 

The interest rate for a credit card (as well as for a personal loan) will depend on your credit score, and if it’s good, you may qualify for a card with a 0% introductory rate. A card with a no-interest introductory period allows you to postpone having to pay for a year, sometimes longer.   

“If you can find a credit card that allows for an initial 12-month interest-free period, and you can afford to pay off the project during those 12 months, credit cards may be a valid option,” says Zachary A. Bachner, CFP, an advisor at Summit Financial in Sterling Heights, Michigan.

You can also get credit cards tailored to your interests and lifestyle preferences, which give you bonus rewards for spending in certain categories, for example dining, groceries or gas. You can then use those rewards — cash back, points or airline miles — to offset the cost of some purchases, or to travel for free. 

“If your credit card has cash back on purchases, reward points, and/or frequent-flyer miles, it might make sense to use it to reap the benefits,” Tayne says. 

“A credit card also provides protection against any fraudulent charges on your account,” Tayne  says. Another positive of credit cards is that making consistent, on-time payments can increase your credit score, she adds. 

The Downsides

 One major disadvantage of credit cards: fees. 

Many credit cards have annual fees, which can be more than $500 for some premium travel rewards cards. If you use a credit card to get a cash advance from an ATM or a bank — a sum you would be borrowing against the card’s credit limit — you’ll also be charged a cash advance fee, which could be up to 5% of the amount withdrawn. On top of that, the interest charged on that cash advance is usually higher than the interest on card balances.  

In addition, if you miss a credit card payment, you’ll be hit with a late-payment fee, although many credit card companies may waive the fee the first time you’re late, if you ask. And if you go over the card’s credit limit, you may be charged with an over-the-limit fee, unless your account is set to decline the transaction if it will exceed your limit.

Even cards with a 0% APR introductory period that let you transfer interest-carrying balances from other cards will hit you with a fee for doing that. Those balance-transfer fees can go up to 5% of the amount transferred.

Credit cards are also quite expensive to use if you do not pay your balances off at every billing cycle. According to the Federal Reserve, the average interest rate for credit cards is 14.65%. Applied to the average balance carried by Americans on their credit cards, which is about $5,300, that means the average card customer would pay $800 every year to carry that balance — and that’s if the balance does not grow, which would result in a higher interest payment.    

Even if you get an introductory rate of 0%, when the introductory period is over the rate will skyrocket. And if you make late payments or go over the limit, credit card companies may increase your interest, in what is known as penalty APR.

The lure of rewards may also push people to spend more than they can afford. “If you use your card to get rewards and then pay off your balance every month, that’s fine,” Vos says. However, if you’re carrying a balance every month and paying the interest on it, you’re likely negating any savings from your rewards.

Alternatives to Personal Loans and Credit Cards

Other than a personal loan and credit cards, there are other options to choose from.

  • Peer-to-peer loans provide money from investors instead of traditional lenders, and don’t require perfect credit.
  • Life insurance loans allow you to borrow accumulated cash from some life insurance policies. A life insurance policy can be used as collateral for a bank loan, as well.
  • 401(k) loans don’t involve any applications or approval processes. But since you’re borrowing money from your retirement, it’s a last resort, and we advise against it, except in some circumscribed cases.

Personal loans and credit cards can provide funds when you’re in a pinch or you don’t want to tap into your cash reserves. However, you’ll need a good credit score for a personal loan, and a clear understanding that credit cards work best when you avoid carrying a balance.