Credit Card vs Personal Loan - Which Is Better?
People receive money in different ways and amounts. While some people earn more than they spend and can save a percentage of their income, others will have to support themselves through credit cards or personal loans. But what is the difference between them? When should you use either of them for personal finance? In this article, we will answer these questions and provide additional information to guide you in making the right personal finance decisions.
Credit Card vs Personal Loan
A credit card allows you to continuously spend money from a credit line to pay for goods and services and repay it, usually with interest. It comes with a limit on the amount of money you can borrow. The card issuer uses your credit rating and income to determine how much you are qualified to borrow and sets the maximum credit limit. In other words, you can get a high limit, which means access to more funds if your credit score is high. However, your card issuer will set a minimum monthly payment which you must make on your credit balance. It will benefit you to try to pay more than this amount regularly.
On the other hand, a personal loan lets you borrow a large amount of money as a single payment that you can receive at a particular time. Then, each month, you are expected to repay a fixed amount of your loan until the end of the "term," which is usually not less than a year. The amount of interest you are to pay depends on the loan and the length of the term. A personal loan can be obtained from a traditional bank, a neobank, a credit union, or an online lender.
One advantage a personal loan has over a credit card debt is that, in most cases, it provides a lower interest rate together with regular and equal payments until the loan is paid off. That is why it is easier to create a budget for a personal loan than for a credit card. You can tell the exact date when you will have cleared the debt.
Below is our comparison of credit cards and personal loans.
When to Use a Credit Card
Use credit cards when you want to make small purchases. For example, you can use them to spend on groceries, electronics, event tickets, offline purchases, and online shopping. They also work best for frequent expenses that will not be difficult for you to pay off. Besides, you should pay off your credit card debt before its due date. By doing so, you can build a good credit score.
When to Use a Personal Loan
The best time to use a personal loan is when you have a large one-off payment to make. For example, you can use it to repair your car or renovate your home. It can also be used for debt consolidation, loan refinancing, or other expenses. A personal loan is not something to use frequently; you might run into big debts. Therefore, get this kind of loan only when necessary.
How Credit Cards and Personal Loans Impact Your Credit Scores
Credit cards and personal loans do more than just give you money to spend and pay back later. They go further to shape your credit history and either positively or negatively affect your credit score, depending on how you are spending and repaying the debt.
When you always make your debt repayments on time, you create a record of being able to manage your debt well. Consequently, your credit score improves. Also, if you can maintain a credit utilisation ratio that is below 30%, you will be doing your credit score a lot of good. Meanwhile, a good credit score starts with any point above 669 and 660 on the FICO and VantageScore ratings, respectively. To learn more about this, read our article on the 12 common mistakes to avoid when opening credit cards.
What are the Four Types of Loans Commonly Used?
When you think of obtaining a personal loan, you must choose from several options. The four main types of loans commonly used today are unsecured personal loans, secured personal loans, payday loans, and buy-now-pay-later loans.
Unsecured personal loan
In simple terms, this refers to a loan that does not need you to provide collateral, such as a car or home, to obtain. Most personal loans are unsecured. An unsecured personal loan is the best option for major purchases. It is also ideal for debt consolidation, which refers to combining many debts into a single loan to pay them off and be free. You will need a good credit score to obtain this type of loan. When choosing an unsecured personal loan, pick the option that has an interest rate and a monthly payment plan that you can afford.
Secured personal loan
There are a few personal loans that require security in the form of collateral. They are known as secured personal loans. To get them, you must agree to allow the lender to seize your home, car, savings, investment account, future paycheque, jewellery, or any other personal valuables in case you fail to pay back the loan according to the initial agreement. A secured personal loan may be useful for saving money on interest.
Payday loan
Payday loans are debts that will not be due until your next payday. They are the best for emergency cash, especially when no other option is available to you. Normally, to repay the loan, you must either send a post-dated check or give the lender permission to automatically deduct the money you owe, and any applicable interest or fees, from your bank account. Moreover, payday loan lenders are governed differently in each country. So, depending on where you reside, your allowable loan amount, loan fees, and payback time will vary.
Buy Now, Pay Later (BNPL) loan
A “Buy now, pay later" (BNPL) loan is a type of short-term financing that lets you pay for a purchase by splitting it into smaller instalments. It is commonly used in online shopping and is often interest-free. You will have to create an account with a lending company or BNPL service provider to get its app for this kind of payment. How does it work? At checkout, you pay for part of the purchase and use the app to authorise your BNPL lender to charge you the rest of the balance later. This kind of loan is usually paid in bi-weekly instalments. It works best for necessary, one-time purchases that you would not otherwise be able to pay for with cash.
Pros and Cons of Credit Cards
Pros and Cons of Personal Loans
Best Credit Card Providers
Nexo
Apart from being a platform for buying and selling digital assets, Nexo lets you borrow digital currencies with a credit line that starts at 0% APR. It issues a Mastercard credit card that has no minimum monthly repayments. Also, you can get back 0.5% in Bitcoin or 2% back in NEXO for every purchase or ATM withdrawal you make with this card.
bunq
Bunq is a fully-fledged neobank that allows people to make easy payments in different parts of the world. It issues a Mastercard credit card for fast and secure shopping online and in-store. You can also use the card to make cash withdrawals at ATMs.
Gemini
Gemini is one of the best-regulated cryptocurrency exchanges in the world. The company provides a crypto credit card known as the “Gemini Credit Card.” With this Mastercard card, you can earn crypto rewards on every purchase, including up to 3% back for your expenses on dining, groceries, and a few others. Gemini does not charge annual fees.
Neon
Neon offers an account for day-to-day digital spending with zero base fees. It issues a Mastercard card that you can use for cash withdrawals at ATMs and payments online and in-store. Neon offers a totally free account. Are you a Swiss traveller? If yes, then Neon is the perfect credit card for you. It allows you to set up standing orders and make free online payments in Switzerland and abroad.
Chime
Do you want to build credit? Are you having credit issues? Get a credit builder secured Visa credit card from Chime! This online-only FinTech company collaborates with The Bancorp Bank or Stride Bank to offer innovative financial services. You can use its Visa credit card to build credit on everyday purchases with no annual fee or interest, no credit check requirement for application, and no minimum security deposit.
Capital One
If you are looking for the right credit cards and other innovative banking services, Capital One may be just what you need. It offers six different types of credit cards, which are cards for credit building, cashback rewards, travel perks, student rewards, and business rewards. In addition, those with average credit scores can use the Capital One Platinum Mastercard card to build credit. It comes with no foreign transaction fees and no annual fee. Also, if you make on-time payments on your account, in about six months, you can earn a higher credit limit.
Klarna
Klarna provides payment services for smooth shopping in-store, online, and abroad. The company's core business focuses on providing BNPL loans that allow customers to pay for purchases in parts. Merchants, on the other hand, can embed convenient instalment purchase options right on the site without much difficulty.
Lately, Klarna offers a Visa credit card that can be used to make BNPL expenses, splitting your purchase into four interest-free payments. You can use the card for free during your first 12 months after registering an account. Besides, Klarna claims that your credit score will not be affected when you use this card. Why is this the case? Instead of a hard credit check, Klarna does a soft credit check when processing your application. Unfortunately, the card is not yet available to everyone. To apply for it, you must be a US resident over 18 and have already made one successfully paid instalment purchase in the Klarna app.
Best Personal Loan Providers
Monzo
One of the best neobanks to obtain a fast personal loan with no hidden fees is Monzo. It offers APRs of 23.9% for loans up to £10,000 and 8.9% for loans above £10,000 but up to £25,000. Monzo charges no fees when you pay extra on your debt or make your repayments early. It lets you choose the amount you need to borrow and how long it will be in use.
N26
N26 is a neobank that offers innovative services that create a world-class 100% digital banking experience. If you want to renovate your home, fund an event, or make any other large purchase but lack enough money, you can get an instant personal loan from this service provider. Up to €25,000 is available to you if you join N26! You can get an instant quote, choose between a six to 60 months loan plan at 1.99% yearly, and receive your loan payments directly into your N26 account.
Loan Alternatives
Do you always have to decide between a credit card and a personal loan? No! There are other options that might meet your needs better than either of them. Popular loan alternatives include:
- Cash-out refinance: This system refers to obtaining a larger loan so that you can use it to refinance your existing mortgage and keep the extra money. It is a viable alternative for anyone who needs to borrow money and obtain a cheaper mortgage rate at the same time.
- Home equity loan: This option is also known as a second mortgage. You can use a home equity loan to borrow against the equity in your home. In other words, as a homeowner, it allows you to take advantage of the equity in your home by using it as collateral.
- Home equity line of credit (HELOC): In contrast to a home equity loan, here, you have access to a credit line that you may use during a draw period and then during the payback period. Only the money you spend will be subject to interest payments.
FAQ
Credit cards and personal loans have their respective purposes, advantages, and disadvantages. Therefore, it is difficult to say that one is better than the other because it all depends on what you want to do. Nonetheless, our advice is that you use a credit card to pay for everyday purchases so that you can earn rewards, but use a personal loan to finance a large purchase or debt payoff.
The interest rate on a credit card loan is what banks and credit card companies require you to pay them for lending their money to you. It is normally expressed as an “APR,” which means “annual percentage rate.”
Credit builder cards are the best for people with credit issues. They often come with high-interest rates and low credit limits to reduce the lenders’ risk of losing their money if the borrower defaults on repayment. But these cards normally do not come with rewards and other promotional features. If you have a low credit score, you can use a credit card like Capital One Premium or Chime to build your credit history.
Credit cards are unsecured loans because they do not require you to provide collateral. Instead, the lenders use your credit score and the record of your debt repayments in the past to determine your eligibility for a credit card.
The amount you can borrow from your credit card depends on many factors, including your available credit and your monthly spending and repayment habits.
Paying off your closing balance before the due date is the best way to avoid interest on your credit card. In addition, the interest-free purchase period on credit cards could be up to 55 days or more.
Make a Well-informed Choice
Now you know the differences between a credit card and a personal loan. We have also shown you their respective advantages and disadvantages and when to use them. Our final advice is that you try to apply this knowledge in managing your finances. That way, you will always make informed decisions concerning the type of short-term financing you should use in any situation. Besides, you can create an account with any of the payment services providers listed in this article.
