Are you looking to borrow money, perhaps for a large purchase or to hold you over temporarily due to a drop in income? There are two main ways you can access funds, but which is better? Let's take a close look at credit cards vs personal loans to help you decide which is best for your situation.
Similarities: Credit Cards Vs Personal Loans
To start, there are some main similarities between most personal loans and credit cards. They are:
- The application review process
- A negative impact on your credit score if you miss payments or pay late
- And the funds are typically unsecured
Here's what each of the similarities between credit cards vs personal loans entails.
Application review process
When you submit an application for a credit card or personal loan, the lender will examine your credit history. The lender needs to see how financially responsible you've been with borrowing money recently and in the past.
They'll also look at your overall financial health and check how much debt you have in relation to your income (debt-to-income ratio). The higher your credit score and the stronger your financial health, the easier it is to get access to credit. In addition, a higher credit score lets you borrow money at lower rates so you'll owe less interest over time.
Ding on your credit score for missed payments
If you're late or miss payments on a personal loan or credit card, expect to see a decline in your credit score. A lower credit score can make it more difficult to access additional lines of credit. You'll also lose access to the best rates.
Thus, regularly monitoring your credit history and maintaining a strong credit score are important to improving your financial health. A high credit score is beneficial not only for access to the best rates, but also for getting a job and applying for financial aid. It can also get you access to the best rewards credit cards.
The majority of credit cards and personal loans offer unsecured funds and can be used for any purpose. What are unsecured funds? That simply means the money you're borrowing doesn't require you to pledge any collateral before you can access the funds.
Collateral refers to assets a borrower agrees to hand over to a lender if they fail to repay the spent funds. Some personal loans are indeed secured and require collateral. However, secured personal loans are less common and are typically for borrowers with poor credit.
Differences: Credit Cards Vs Personal Loans
Now let's look at the primary differences between personal loans and credit cards.
Revolving credit vs installment loan
The largest difference between credit cards and personal loans is their type of credit. Revolving credit lets you borrow money as you need it. This is the type of credit that credit cards use.
Think of revolving credit like a borrow-as-you-go credit format. How much you owe your credit card company each month depends on your outstanding balance at the end of each period, typically the end of each month.
Some months you may have $0 due if you didn't spend anything. Other months you may owe a lot more depending on how much you charged to your credit card.
Personal loans are setup differently than credit cards. They are installment loans, meaning you receive a lump sum of money up front. Unlike credit cards, the amount you can borrow doesn't change from month to month. It's determined when you apply.
In addition, the date you're expected to return all of the funds to the lender is also determined during the application process. Then, it's up to you to pay off the loan every month in equal installments. That monthly payment amount is determined during the application process. You can always pay extra if you want. But if you do not pay the full monthly payment amount, you will face fees and penalties.
There are some other differences that credit cards can offer that personal loans don't. For example, many credit cards have rewards programs where you can earn points or airline miles based on how much you spend each month. Some cards also offer 0% interest introductory offers on balance transfers or new purchases.
Credit cards also do not have a termination date like personal loans. In other words, you can keep a credit card active indefinitely if you remain in good standing. You could also stay in debt much longer with a credit card than you might with a personal loan.
Some people have credit card debt for multiple decades because they keep spending and never pay it off in full. If you've racked up a lot of debt, please read these steps on how to get out of massive credit card debt.
A benefit of credit cards over personal loans is you can avoid owing any interest if you pay the full balance due each month. The interest rates on credit cards tend to be higher than those of personal loans, however. So not paying off the balance in full can get very expensive very quickly.
In addition, interest rates are fixed on personal loans. This means the rate does not change for the entire duration of the loan. Credit cards have variable interest rates, however, so the rates can fluctuate on any unpaid balances.
The types of fees you may face are another difference for credit cards vs personal loans. Some examples of credit card fees may include annual fees, late payment fees, and foreign transaction fees. Personal loans can have origination fees and late payment fees.
When To Use Credit Cards Vs Personal Loans
Now that you understand the main similarities and differences between credit cards vs personal loans, which is best for you? Here are some reasons to choose a credit care over a personal loan
Reasons to choose a credit card
- Short-term financing is your main goal.
- You're looking for a way to cover day-to-day expenses that you can repay quickly.
- You want the convenience to be able to use it when you need it.
- Earning rewards is important to you and you have a good or excellent credit score.
- You qualify for a 0% introductory offer and want to avoid paying interest.
Reasons to choose a personal loan
- You need money quickly for a large one-time expense.
- Consistent monthly payments for 2-7 years is preferred.
- You qualify for a low annual percentage rate (APR).
- You want to consolidate and pay off a lot of high-interest debt.
Related reading: How To Get A Personal Loan With A Low Interest Rate
Are Interest Rates Higher For Credit Cards Vs Personal Loans?
You bet they are. Interest rates on credit cards are notoriously high, which is why having revolving credit card debt can be detrimental to your finances. Even when interest rates dropped near zero during the pandemic, credit card interest rates stayed in the double digits. Please make it a priority to pay off your credit card balance in full each month for the benefit of your financial health.
Lending rates are constantly changing. In addition, your credit score and financial situation largely impacts the rates you qualify for. Borrowers with excellent credit can typically qualify for personal loans in the upper single digits. But it's practically unheard of for even the very best borrowers to qualify for credit cards in the single digits.
If you want to get personalized prequalified rates, check out Credible. They are a trusted lending marketplace where lenders compete for your business, saving you money.
You can also get more tips here on how to compare personal loan rates.
Alternatives To Credit Cards And Personal Loans
Credit cards and personal loans aren't the only options for borrowing money. Here are some other alternatives.
Home equity loan. If you're a homeowner, you can borrow against the equity in your home. This is one way to qualify for low interest rates. The risk is you could lose your home if you can't make your monthly payments.
Home equity line of credit (HELOC). Similar to a home equity loan, your home serves as collateral for this type of credit line. The difference is you can access credit during a specified draw period that is followed by a repayment period. The interest you owe is based on the amount of money you use.
Cash-out refinance. Another option for homeowners is to refinance your mortgage for a larger loan and keep the difference as cash. It's a way to borrow money and lower your mortgage rate simultaneously.
Business loans. If you're a business owner or want to start your own company, a business loan is more appropriate than a personal loan. It's important to keep your personal and business finances separate. Be prepared to provide financial statements and projections for your business during the loan underwriting process.
Payday loans. This is the absolute worst type of debt to have, so only chose a payday loan if you have no other option. They are short-term loans with very high interest rates where borrowers get cash advances on their paychecks.
Today you learned about the similarities of credit cards vs personal loans. They share a similar application review process, are typically offered as unsecured funds, and can have a negative impact on your credit score if you miss payments or pay late.
Credit cards offer revolving credit whereas personal loans are installment loans. Credit cards can also come with benefits like rewards programs that personal loans do not. You can also avoid paying interest with credit cards if you are able to pay your balance in full each month.
Personal loans are a good way to access money quickly for large one-time expenses. Credit cards are best for day-to-day expenses and convenience.
There are also several borrowing alternatives such as home equity loans, cash-out refinances, and business loans to consider.
Get Personalized Prequalified Rates With Credible
If you want to get personalized prequalified rates, check out Credible today. They are a trusted lending marketplace where lenders compete for your business, saving you both time and money.