Knowing how personal loans and credit cards are different and how they are the same can help you decide which one is better for your finances.
To pay for an unexpected expense, you can get a personal loan or use your credit card to borrow money.
Credit cards are a type of revolving credit. A borrower’s credit limit tells them how much they can use over and over again. Personal loans are a type of installment credit. The full loan amount is given to the borrower up front, and then the borrower makes regular payments until the debt and interest are paid off.
Whether someone uses a personal loan or a credit card depends on what they need. How much you pay in interest on personal loans and credit cards will depend on how good your credit is. Borrowers with good credit scores might get lower interest rates, while those with bad credit scores might have to pay higher rates.
Personal loans and credit cards are both forms of unsecured credit, but there are some important differences between the two.
What is a loan to yourself?
A personal loan can give you the lump sum of money you need. The loan is paid back in fixed amounts over a certain amount of time. Interest rates on personal loans are often set. You’ll know how much it will cost to pay off the loan and how often you have to make payments. Borrowers have to pay back the loan amount, the interest, and any other fees that come with the loan.
Credit unions, banks, and online lenders are all places where people can get personal loans. Interest rates will be different for each borrower based on things like their credit score.
Types of personal loans that are common:
Personal loans are a type of installment loan, but installment loans are a large group of loans. Installment loans are often used for mortgages, auto loans, and student loans.
bad credit loans
People with low credit scores who might not be able to get a traditional personal loan might want to look into bad credit loans. Bad-credit loans work like personal loans in that the borrower has to pay back the loan over a set amount of time and on a set schedule. But because lenders may be hesitant to lend money to people with bad credit, the loans may have high-interest rates, fees, and penalties.
No credit check loans
When a loan is called a “no-credit-check loan,” it means that the lender doesn’t look at the borrower’s credit report. Instead, lenders may do a “soft inquiry” on the borrower’s report, which doesn’t affect the borrower’s credit score. This type of loan includes things like payday loans and cash advances.
When you might need a personal loan
1. You need a lump sum
Because the whole loan amount is given to the borrower at once, personal loans can be useful for big, unexpected costs like a $2,000 roof repair to fix a leak.
Jodi Letkiewicz, Ph.D., an associate professor in the School of Administrative Studies at York University, says, “If you need the money to buy something specific or for a certain amount, you want a personal loan.” “If you want it to make spending easier, you want a credit card.”
When you know exactly how much money you need for a one-time expense, a personal loan can help. Because of this, it’s common for people to get a personal loan to pay off debt, fix their car, or get medical care in a hurry.
2. You prefer consistent payments.
Most personal loans have a fixed amount, rate of interest, and length of time. The people who borrow money will know in advance how much they have to pay each month. It’s important to know that the monthly payment for a personal loan is often higher than the minimum monthly payment for a credit card.
Leslie Beck, CFP, MBA, owner of Compass Wealth Management LLC, says, “A personal loan is best if you know you can make the payments for the time needed and that this is a one-time debt.”
3. You want to pay for a big purchase with a loan.
If you have a big expense, a personal loan may be a better choice because you can pay it off over time. You could buy something big with your credit card, but you might risk going over your credit limit. You’ll also need to be ready to pay by the end of the month, when your statement is due, to avoid interest charges.
How do credit cards work?
Credit cards are like a line of credit or a home equity loan in that they let you borrow up to a certain amount every month. They are easy to use for everyday shopping.
Credit card companies usually want you to make a minimum payment on your debt every month. How much you have to pay depends on how much of your credit line you’ve used that month.
Even though flexible payment plans can be helpful, if you can’t pay the minimum amount each month, it can cost you.
“Whether you have good credit or bad credit, you should never put more on a credit card than you can pay for,” Letkiewicz says.
If you don’t pay off your credit card balance in full by the end of the month, interest will be added to your debt.
Types of credit cards that are common:
credit card for beginners
If you don’t have a credit history or if your credit file isn’t very full, a starter card may be a good way to get started with credit cards. Most of the time, credit card companies will report your payment history to the three major credit bureaus (Experian, Equifax, and TransUnion). This is because credit cards are meant to help people build their credit histories.
Cards with low-interest rates
You may have also seen these cards advertised as credit cards with 0% APR. Most of the time, you can use these credit cards without paying interest for the first 6 to 24 months. During the introductory period, neither new purchases nor balance transfers will be charged interest. But these introductory periods don’t last forever, and after the introductory period is over, credit card companies usually switch to a standard interest rate.
Student credit cards
Student credit cards are made just for college students to give them access to credit. To get one, you must be at least 18 years old and either a full-time or part-time college student. These cards are a good way to start learning about credit cards.
How to use a credit card
1. You value convenience.
Credit cards can be used almost anywhere, from brick-and-mortar stores to online shops. They’re great for making small purchases every day because you can borrow money on an ongoing basis.
Beck says, “Credit cards have limits that might not be enough for big purchases.” “But once you have a credit card, you can always use it, as long as you don’t take advantage of it.”
2. You want to use it for a long time.
People can borrow money from their credit cards as many times as they want, up to their credit card limit. You can keep using the card as long as your account is still open and in good standing. A personal loan has a set end date, which makes it better for short-term expenses. After a personal loan is paid off, the person who took it out will have to apply for new credit.
3. You’re an excellent money manager.
People who carry a balance on their credit cards can pay a lot for this type of debt. If someone wants to avoid credit card debt with high-interest rates, they need to pay off their balance in full every month.
Letkiewicz says that credit cards are a good choice for people who can keep track of their money and pay them off every month. “Interest can eat you alive if you carry a balance on your card.”
Credit cards and personal loans both let people borrow money that they will have to pay back later. However, there are some big differences between the two. Before you decide if you need a credit card or a personal loan, you should always look at your needs and do some research.