When is a Personal Loan more suitable than a Credit Card?

The next time you need money, you will probably think about getting a personal loan or a credit card.  There are several reasons that people consider a personal loan, but debt consolidation, home improvement, car purchases and going away for a holiday are some of the main reasons. Naturally, the primary question revolves around which of the two is cheaper. Often people focus on finding the lowest interest rate and  fail to consider other factors.

Comparing Costs – Interest rate, application fees and annual fees

When you make a comparison of the interest rates charged on personal loans and credit cards, personal loans usually come out on top. This is because personal loans charge an average variable interest rate of several percentage points less than their credit card rivals.

On the other hand, personal loans frequently have an application fee, while a credit card seldom charges an application fee. Although, credit cards often charge an annual fee. It  could be expensive in either the case of personal loans or credit cards.

However, how much you need to borrow, how quickly you will be able to pay back what you ow,e and your own personal spending habits also needs to be taken into account.

You can use the Credit Card Finder® calculator to make these calculations.

Big Purchases vs. Small Purchases

Credit cards have the advantage of acting as ‘revolving credit.’ What this means is that you are given a spending limit of, say, $1000 and you are free to spend up to this amount as long as you pay the debt back plus some interest. So a credit card can be useful for paying off small purchases when you don’t have the cash on hand.

The opposite is true for personal loans because they are generally suited to larger purchases like a car. Loan rates tend to be higher the less you want to borrow, so if you need to borrow only a small amount, you may be better off with a credit card.

Borrowing Period

You need to be realistic in how long it is going to take you to pay off what you owe.  Some credit card companies offer a 0% introductory interest-free period for purchases. If you can clear your debt during this period you would not be charged any interest in the money you borrowed.  However, after the interest free period ends, many credit cards revert back to charging incredibly high interest rates.

If you are not certain that you can pay back what you owe during the interest free period, or you know that you would like to pay back the amount over a longer period of time, a personal loan will likely offer you a more competitive interest rate over the life of the loan, which will result in you paying less interest overall.

Personal Spending Habits

If you know that you have little difficulty in controlling your spending habits and have always paid your debts on time, then getting a credit card may be a good option. Many personal loans charge a penalty if you repay early, so credit cards offer flexibility in paying back your debt.  You can pay as much as you would like each month as long as the minimum payment is being met.

However, that flexibility can cause problems if you are not very self-disciplined about clearing the debt.  The biggest trap that people get caught in with credit card debt is paying off just the minimum amount each month, actually prolonging the length of time it takes to pay off the debt in full and therefore paying more interest than they anticipated.

If you are prone to overspending and not paying the debts on time, a credit card may not be ideal. The main benefit of a loan is that managing your debt is straightforward and easy as you pay back a fixed amount each month until the entire amount is paid back.

Remember – a fixed interest rate means a fixed repayment.  With a personal loan you never have to guess how much your payment is going to be each month, you will know exactly how much you have to pay each month and often is arranged to come automatically out of your bank account, saving you time and money (no accidental late fees).

Choosing the best for you:

Keep in mind, there is no guarantee that you will be accepted for a loan or a credit card, so make only realistic applications, as rejected applications can hurt your credit rating.  The decision to choose between a personal loan and a credit card really boils down to choosing a product with the lowest combination of interest rates and fees, while taking an honest look at your spending needs and repaying behaviour before deciding on the product that best fits you.

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