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Personal Loan vs. Credit Card: Which is the Best Choice?

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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 loanCredit card
DefinitionAn unsecured loan with usually fixed interest rates and monthly paymentsAn unsecured line of credit with flexible spending and monthly payment terms
APRVaries 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 limitsTypically from $1,000 to $50,000Depends on your credit score and the company
CollateralSecured loans are available and can help build or rehabilitate creditA credit card secured with a security deposit may help build credit
Benefits

 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

Drawbacks

  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

FeesLoan origination fees, late payment fees, prepayment penaltiesAnnual 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 typeCredit range
Poor300-579
Fair580-669
Good670-739
Very good740-799
Excellent800-850

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 bandAverage APR
720+10.58%
680-71917.00%
660-67924.16%
640-65931.95%
620-63940.57%
580-61963.58%
560-579100.53%
Less than 560136.88%

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

ProsCons

  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

ProsCons

  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 designed for borrowers with 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.

How it compares to credit cards: A personal line of credit may require a fee for every withdrawal, so a credit card might be better for everyday purchases.
How it compares to personal loans: A personal line of credit lets you borrow money only when you need it, while a personal loan comes as a lump sum, and you’ll owe interest on the entire amount.

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.

How they compare to credit cards: You may qualify for better terms with a home equity loan or HELOC, but you’ll also have to put your home up as collateral.
How they compare to personal loans: Borrowing against home equity typically gives you a lower APR than borrowing with a personal loan.

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.

How it compares to credit cards: You’ll still end up paying interest on purchases if you don’t pay your balance off before the 0% promotional period ends.
How it compares to personal loans: Personal loans offer fixed monthly payments, and you might be able to secure the same type of financing with a payment plan — and put off paying interest.

Cash-out refinance

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.

How it compares to credit cards: You may get lower interest rates with a cash-out refinance than with a credit card, but that’s also because your home is used as collateral.
How it compares to personal loans: Similarly, because a cash-out refinance is secured with your home as collateral, you may be able to qualify for lower interest than with a personal loan.

Payday loan

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.

How it compares to credit cards: Like a credit card, it’s best to pay these types of loans off quickly as possible, though because the interest rates can be astronomically higher, credit cards may be the better option.
How it compares to personal loans: While payday loans are limited to just $500, personal loans offer much more flexibility when it comes to loan amounts.

Business loan

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.

How it compares to credit cards: You may be able to get a lower rate than with a credit card, though it may depend on your credit worthiness.
How it compares to personal loans: You may be able to get a much larger loan than with a personal loan, but the business loan process is much more in-depth.

Personal loan vs. credit card: FAQ

Whether a loan works better for you than a credit card will depend on your financial situation. 

If you’re confident about the amount of money you need, could use a lump sum of cash and like having fixed interest rates, a personal loan may be best for you. 

On the other hand, a credit card may be the better option if you’re able to secure a 0% interest promotion on a new card or like the idea of having credit on a rolling basis.

Generally speaking, it’s best to avoid loans that can be predatory, such as payday loans and pawn shop loans. While these types of loans don’t typically require credit checks, their interest rates and fees can put you in a tight position financially and make it hard to pay them off.

While, in some cases, you can pay a personal loan with a credit card, it depends on the lender and the type of loan you have. If you choose this method, however, you’ll want to make sure you can pay that debt off quickly and do it with a credit card that has low or 0% interest.

 

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