Are Personal Loans a Cheaper Alternative to Credit Cards?
If you’re looking to borrow money at a low interest rate, you may wonder if personal loans are a cheaper alternative to credit cards. For many people, personal loans may be cheaper than credit cards, but that’s not always the case.
Personal loans offered through LendingTree’s marketplace start as low as 3.49% APR for those with excellent credit. But APRs can reach triple digits in some instances for those with poor credit, and added costs like origination fees can push your rate even higher.
Meanwhile, the average interest rate for credit card accounts assessed interest was 16.86% in November 2018 — the latest available data — according to the Federal Reserve. But you could qualify for a 0% introductory offer on purchases and get an APR lower than that of a personal loan — at least for up to 21 months before the teaser rate expires.
Many factors besides interest rates go into choosing the best borrowing option for your financial situation. It pays to learn more about personal loans and credit cards before making a decision.
Benefits and costs of a personal loan
A personal loan can provide you as much as $50,000 in less than a day if a lender deems you a good credit risk. Let’s go into more detail.
A personal loan typically comes with a fixed interest rate, while a credit card typically has a variable APR. If your credit card issuer decides to increase your interest rate because you’ve made a late payment or the Federal Reserve hikes its benchmark rate, you could be in for a surprise that affects your budget.
“The advantage with a personal loan is you know exactly what you’re paying each month and how long it will take to pay off the loan,” said Christine Centeno, a certified financial planner and founder of Simplicity Wealth Management, a financial investment and wealth management firm. “It’s easier to plan and budget with a predetermined term and fixed payment amount.”
Taking out a personal loan may also boost your credit score. Personal loans are installment loans, which can help to diversify your credit profile if you already have a few credit cards.
If you have cash in a savings account, you might consider a secured personal loan. Secured personal loans use your savings or certificates of deposit as collateral, so you may qualify for a lower interest rate regardless of your credit score.
Borrowing money often comes at a price. Personal loans may have some of the following costs attached:
- Origination fee, which you pay upfront to a lender to cover the costs of processing your application. The fee can range from 0% to 8%.
- Late fee, which varies by lender. For instance, Wells Fargo charges a late fee of $39 but provides a 10-day grace period before you are charged.
For the best deal, look for a lender with no origination fee or prepayment penalties. When you’re comparing interest rates, be sure to consider the APR, which is the overall cost of the loan expressed as a percentage. An APR would incorporate any origination fees or other costs.
There are also other things to consider with a personal loan. If you make a late payment or default on the loan, your credit score could drop, making it harder to obtain credit in the future. If you default on a secured loan, you could also lose your collateral.
Benefits and costs of credit cards
Many Americans reach for credit cards to cover emergency expenses, medical bills and luxury vacations. Total credit card debt in the U.S. surpassed $1 trillion in 2018, according to the Federal Reserve. Let’s discuss the benefits and costs of credit cards.
If you can take advantage of a 0% balance transfer offer or introductory rate and pay off the credit card within that period, you can save money over a personal loan. “Zero percent teaser rates may seem like a no-brainer,” Centeno said.
Since a credit card is a revolving line of credit, you can make charges, pay it off and borrow again, which is convenient if your financial needs fluctuate.
Some credit cards also give you an opportunity to earn rewards on your purchases. “If you can pay off the balance and don’t pay 17% to 24% in accrued interest, rewards can be worth it,” Centeno said.
Like personal loans, credit cards also come at a price. Some of the costs you can expect to pay include:
- Balance transfer fee, which could be between 3% and 5% of the amount you’re transferring.
- Annual fee (on some cards). Credit cards may have annual fees upward of $550 per year, and some may come with an introductory $0 annual fee the first year.
- Late fees, which can be as much as $28 for your first late payment and up to $39 for subsequent late payments — but cannot be more than the minimum amount due.
If you plan to take advantage of a balance transfer offer, make sure the fees won’t add up to more than the interest you are saving, or look for a card with no balance transfer fees for the first few months.
Always remember that there will be a difference in your costs depending on whether you get a 0% intro period, which we’ll detail next.
When a credit card makes more sense
Many Americans use credit cards with 0% balance transfer offers to pay off higher-interest credit cards, which can be a smart move if you have the discipline to pay your balance in full before the introductory period ends.
“Be careful not to stretch yourself too thin chasing after a 0% offer,” said Centeno, who advises consumers to take their credit utilization ratio into account before maxing out a credit card by transferring higher-interest balances.
“Having a balance near the limit of your credit card and maintaining it for the entire promotional period will negatively impact your utilization rate — and, as a result, [it] could lower your credit score,” she said.
Also, if you need to make a major purchase, such as a new appliance or car repairs, a credit card with a 0% introductory APR can save the day.
Centeno recommends calculating the monthly payment over the promotional term and putting that money into a savings or money market account each month while also paying the minimum on your credit card bill. At the end of the promotional term, use the money in your savings account to pay off the credit card.
“You’ve got the added bonus of earning interest on your money market account,” she said. “You’ve played the interest rate spread to put money in your pocket.”
If you’re positive you can pay off your credit card balance before the introductory offer ends, you’ll save money with a credit card.
When a personal loan makes more sense
If you need more time to pay off high-interest credit card debt or a major purchase, a personal loan can help. Terms typically max out at five years, but lenders such as LightStream offer as much as 12 years. Beware, though, that your APR will likely be higher with a longer term.
If you absolutely need to borrow money to pay for a wedding, a personal loan could be easier than putting the expense on multiple 0% interest credit cards, though avoiding a personal loan or a credit card is really the best option in this situation.
If you used a credit card with a 0% introductory interest rate to consolidate debt or finance a large purchase, you may be nearing the end of the introductory period and realize you cannot pay your balance in full. If you can’t qualify for another 0% APR credit card, you might be able to secure a personal loan with a lower fixed interest rate than your credit card’s new variable APR. If your finances improve, you can always pay off the loan faster than you intended.
Another reason you may want to obtain a personal loan instead of using a credit card is to diversify your credit portfolio.
Your credit score is calculated based on a number of factors, with credit mix making up 10% of your score. If you already have several credit cards and need to borrow money, securing a personal loan could boost your credit score. On the other hand, charging one of your credit cards to its maximum limit will hurt your score through your debt-to-credit ratio.
The bottom line
Americans have many choices when it comes to borrowing money.
If you are financially disciplined and have the credit score to qualify, a 0% balance transfer offer on a credit card may be your best choice for debt consolidation. But a low-interest personal loan may help you take control of your financial future.
Always make sure to carefully compare your options before making a decision.