Personal Loan vs. Credit Card: Which is the Best Choice?
When it comes to a personal loan versus a credit card, the option that’s best for you depends entirely on your situation and financial needs.
A personal loan lets you borrow a lump sum of money that is repaid over a set period of time with a fixed interest rate. A credit card, on the other hand, lets you borrow money on a rolling basis at variable interest rates.
When weighing your options, there are clear pros and cons to consider. Here’s how to decide which product is right for you.
Difference between a personal loan vs. credit card
Personal loans and credit cards are two unique financing options, and how to decide which one is right for you will depend on factors including how much money you need to borrow, the annual percentage rates (APR) you are offered and how quickly you can pay it back. Choosing the best path for your financial situation will require some research.
Personal loans vs. credit cards
|Personal loan||Credit card|
|Definition||An unsecured loan with usually fixed interest rates and monthly payments||An unsecured line of credit with flexible spending and monthly payment terms|
|APR||Varies widely depending on creditworthiness, but can be as low as 5% or as high as 36%||Varies widely according to type of card, but APRs for new credit card offers now range from about 17.19% to 24.45%|
|Borrowing limits||Typically from $1,000 to $50,000||Depends on your credit score and the company|
|Collateral||Secured loans are available and can help build or rehabilitate credit||A credit card secured with a security deposit may help build credit|
Borrow a lump sum of money
Usually comes with a fixed interest rate, so you’ll always know what you owe
You may qualify to borrow large sums of money
You may qualify for a lower APR than with a credit card
Borrow what you need on a rolling basis
Funds are available when you need them, up to a predetermined limit
You may qualify for a 0% introductory interest rate valid for six months or more
You may be able to earn rewards on your spending
Subprime borrowers will have a hard time qualifying for good terms
Missed payments will hurt your credit score
Interest rates are typically variable, so your APR may increase
APRs can be high for borrowers with subprime credit
|Fees||Loan origination fees, late payment fees, prepayment penalties||Annual fees, late payment fees, penalty APRs for delinquent accounts|
Understanding your credit score
Since both personal loan and credit card approvals are based heavily on your creditworthiness, it’s important to understand your credit score and how it may impact you.
Personal credit scores typically run between 300 and 850 and are usually based on the FICO Score or VantageScore models, though most lenders use FICO. The higher the number, the better your score is considered to be.
FICO Score model credit bands
|Credit type||Credit range|
Your FICO credit score is based on the following factors:
- Payment history: 35%
- Debts owed: 30%
- Credit history length: 15%
- Types of credit: 10%
- New credit: 10%
Below is a chart on what kind of APR you may be offered on a personal loan depending on your credit score. As you may notice, the higher your credit score, the lower your APR.
Qualifying for a credit card works similarly, though the rates won’t be fixed like they are for personal loans.
|Credit band||Average APR|
|Less than 560||136.88%|
Source: LendingTree user data on closed personal loans for Q2 2022
Personal loan vs. credit card on credit score
If you’re learning to use and build your credit, a credit card may be best for some consumers, since you can learn to manage smaller payments rather than one large lump sum.
However, both personal loans and credit cards can impact your credit score. While both can help you to build credit, both can also put a dent in your score.
- Both require hard-credit pulls. When you first apply for a credit card or personal loan, many companies offer you the opportunity to prequalify by doing a soft-credit check. This will have no impact on your credit score and allow you to see what sort of rates you may qualify for. However, should you decide to proceed with the personal loan or credit card, companies will perform a hard-credit pull, which can temporarily lower your credit score.
- Both can increase your debt-to-income ratio. Your debt-to-income ratio (DTI) is the amount of debt you have accrued compared to your income. Your DTI ratio determines around 30% of your credit score — and the lower it is, the better it looks in the eyes of lenders.
When it’s best to use a personal loan
Personal loans may be best for those who know exactly how much money they need to accomplish their financial goals or cover their expenses.
This type of debt may also be better for those who can qualify for a lower APR on a personal loan rather than on a credit card, as well as those who need to consolidate debt or refinance their credit cards. This approach can help consumers save money in the long run.
According to a LendingTree study, researchers found that high-score borrowers were most likely to take out a personal loan for the following reasons:
- Debt consolidation: 39.7%
- Credit card refinancing: 15.8%
- Home improvements: 12.8%
- Major purchases: 7.6%
- Car financing and repair: 2.8%
- Medical expenses: 1.9%
- Business/moving/relocation costs: 1.5%
- Vacation/wedding expenses: 1.0%
Pros and cons of using a personal loan
Interest rates are typically fixed, so you’ll know how much to budget for each month.
Personal loans are typically unsecured, so you won’t have to provide collateral.
Since personal loans come with repayment terms, you’ll have a good idea of how long it will take to pay it off.
Many personal loans come with origination fees, which are often taken out of the total amount of money you receive.
Unsecured personal loans often require a robust credit profile and score in order to qualify for low APRs.
If you’re unable to repay the personal loan, your lender can sue you for repayment.
When it’s best to use a credit card
Credit cards may be best for those who can qualify for a 0% APR introductory offer and are in need of a flexible borrowing amount, since they are offered a line of credit instead of a lump sum.
Credit cards may also be an attractive option for consumers who want to earn rewards on their purchases. Unlike a personal loan, using a cash reward credit card can help you score points, travel miles or cash back.
When using a credit card, it’s typically best if you can pay off your full balance each month. Carrying a balance month to month can make everyday purchases more expensive. If you can pay off your balance in full every month, however, you’ll avoid interest charges.
In the U.S., the average credit card interest rate is 20.82%, according to LendingTree data.
Pros and cons of using a credit card
You may be able to accrue points when you make purchases and earn rewards toward travel or cash back.
Can be a simple, short-term solution if you need extra cash quickly that can help you build credit.
Credit cards often have high levels of security.
Because the interest rates vary month to month, it may be hard to budget for how much your bill will be.
Since it works like a revolving line of credit, it may lead some consumers to overspend.
Some credit card companies charge users an annual fee, though you can shop around for credit cards without the annual fee.
Personal loan vs. credit card: Which is best for debt consolidation?
If you have multiple forms of debt you have to track, it may be time to roll your debts into a single monthly payment. Both personal loans and credit cards offer ways to manage that debt.
- Debt consolidation loan: When it comes to personal loans, many lenders offer debt consolidation loans. This involves taking multiple debts and rolling them into a new loan, ideally at a lower interest rate than what you’re already paying. While these types of loans usually don’t come with transfer fees, some lenders do charge origination fees, which will come out of your total balance. Debt consolidation loans are best for those who need more time to pay off their debts. There are also a number of debt consolidation loans for bad credit.
- Balance transfer credit card: These types of credit cards allow you to transfer debt onto a credit card. Some balance transfer credit cards even come with 0% APR for a period of time so you may not have to pay interest when you first get the card. However, once the promotional period ends, you’ll have to pay interest on the remaining card balance. In addition, keep in mind that balance transfer cards typically charge a 3% to 5% fee to transfer debt. This form of debt consolidation may be best for those who have a small amount of debt and can afford to pay it off during the 0% APR promotional period.
Alternatives to credit cards and personal loans
Personal line of credit
A personal line of credit is a hybrid between a personal loan and a credit card. Like a personal loan, it comes with a predetermined borrowing amount and usually doesn’t require collateral (a secured personal line of credit will need collateral). However, a personal line of credit also lets you draw funds on an as-needed basis, and you only pay interest on what you use.
Home equity loan and home equity line of credit (HELOC)
If you have equity in your home, you may be able to secure financing with better terms than with an unsecured personal loan or credit card.
Home equity loans and HELOCs let you borrow against the value of your home, so they’ll typically come with lower APRs than unsecured forms of financing. However, they usually also come with extra fees and closing costs, and you risk losing your home if you default on either borrowing option.
Buy now, pay later
If you’re thinking of opening a personal loan or credit card to finance a big purchase, you may want to explore buy now, pay later options first. Many retailers offer 0% promotional financing if you pay with a store credit card and pay off the balance within a set time.
Still, make sure to read the fine print, though. For most buy-now pay later options, you need to pay off your balance before the 0% interest promotional period ends. If you don’t, you could be on the hook for back interest.
Similar to home equity loans and HELOCs, a cash-out refinance allows you to utilize your home equity to put money toward anything from a home improvement project to paying off debt.
With a cash-out refinance, you have the option to essentially replace your current mortgage with a larger one and keep the extra cash to do with as you please. You can typically take out up to 80% of your home’s value.
Because of their high rates and fees, payday loans typically aren’t an ideal option for borrowers. Borrowers will typically have between two and four weeks to pay them off, and the APR can get as high as 400%. Plus, payday loans are typically capped at $500.
If you do need a loan quickly and can afford the high interest and fees, a payday loan may work as a short-term financial Band-Aid. Still, we recommend safer financing alternatives over this option.
If you need some extra cash to cover your business’s expenses, consider a business loan instead of a personal loan or credit card.
This may be a good option, particularly if you’ll need to cover a large expense, as business loans tend to offer much larger lump sums than personal loans. For instance, Small Business Administration loans (SBA) can range as high as $5.5 million.