Are you thinking of making a large purchase? Or just want some additional money for everyday purchases before you receive your salary? In this article, we tell you the differences between getting a credit card and availing of a personal loan.
Many might think the answer is fairly obvious – personal loans have a lower interest rate, and they’re cheaper over the long run.
However, there’s more to it than meets the eye. For example, if you are likely to pay off your debt before its due date, a credit card lets you benefit without any interest expense. However, if you are making a large purchase, it makes more sense to get a personal loan.
In this article, we help you understand the differences between a credit card and a personal loan and give you scenarios when it makes sense to get one instead of the other.
What is a credit card?
A credit card is a regular thin piece of plastic or metal issued by a bank or financial institution. It allows you to borrow money to purchase goods and services on the condition that you will pay the credit card company back at a future date.
Credit cards provide you with revolving credit. This means that you can spend money on credit, pay it back with on-time payments, and repeat the cycle.
The amount of money you get to spend on credit depends upon your credit limit or line of credit. As the name suggests, credit limits determine how much you can borrow from your bank or credit union at any given time. Financial institutions and card issuers often determine the credit limit for an individual based on their income, credit score and credit history, and other factors.
You can choose to pay off your credit card debt entirely at the end of each billing cycle or carry over your debt from one month to the next. However, you must make at least the minimum payment on your credit each month.
If you use a credit card, you will typically receive a credit statement indicating the amount you need to pay back at the end of a month or billing cycle. If you fail to repay your credit by the due date, you may incur interest charges and late payment fees. The average interest rate on a credit card is 16.28%.
When should you use a credit card?
Typically, you should use your credit card for small daily expenses, monthly bills, or other purchases. Consider whether you can pay back your credit at the end of the month before spending money on your credit card.
If you are unsure whether you can pay back your credit soon, it’s worth noting that many credit cards come with a grace period after the end of a billing cycle. A grace period allows you to pay back your credit interest-free until 21 days after the due date.
What is a personal loan?
Personal loans allow you to borrow a lump sum in the short term. You are required to pay back this money in installments with interest over a fixed period, but the repayment terms can vary. The average interest rate for a personal loan taken for 24 months is 9.65%.
When taking out a personal loan, you can decide your monthly installments and term length. Financial institutions’ approval of your loan and interest rates depend on your ability to return the payment with interest, the size of the loan, and the time you will take to pay it back.
If you think you cannot pay back your credit in time, exploring other services besides credit cards might be worth it.
When should you use a personal loan?
Personal loans are recommended for large, one-time purchases such as buying a car or a house. Personal loans have a lower interest rate than credit cards, making them a popular choice for financing big purchases.
One of the main drawbacks of choosing a personal loan is that providers charge an administrative fee for their service. Additionally, if your loan amount is backed by collateral, you risk losing your collateral if you fail to meet the loan’s terms and conditions.
What is the benefit of credit cards over personal loans?
Reward schemes make credit utilization extremely beneficial for financing daily expenses. Most credit cards offer rewards to consumers, allowing you to receive a gift based on your spending. You may receive these gifts in the form of loyalty points or cash back offers. For example, many credit cards let you exchange your loyalty points for flight tickets or other exciting travel and shopping offers.
At Vital, we believe giving users cash back is the best gift, and so we give you 1.5% cash back on all your purchases.
So, if you pay back your credit before it is due on a 0% intro APR credit card, you can enjoy the rewards that your credit card provides without paying interest. However, these perks are not available to you while taking out a personal loan since they offer no benefits.
Credit cards require discipline as many people often lose the benefits by taking more than they can repay. In such cases, one inevitably pays more in interest.
A credit card also allows borrowers to build their creditworthiness over time. Credit cards (like Vital) help you increase your credit score by rewarding you for paying back your credit card balance on time.
This is particularly helpful if you plan to borrow money through a personal loan in the future because financial institutions decide the terms and conditions of your personal loans based on your credit score.
What is the benefit of personal loans over credit cards?
The main benefit of taking out personal loans is their low-interest rates. Lower interest rates help you finance large purchases with manageable monthly payments.
However, you may be charged higher interest rates if you have a poor credit score. In such cases, financial institutions often charge higher interest rates to compensate for their risk of providing you a loan.
Taking out large amounts of credit might not always be possible with credit cards because of your credit limit. Moreover, since, in most cases, a large purchase cannot be paid back in a month, this is a terrible strategy because you’ll be liable to pay a high-interest rate. In cases like these, it makes more sense to avail of a personal loan.
Many people spend more than they can repay because credit cards offer easy credit access. Therefore, credit cards can be costly if you are irresponsible or easily carried away. However, this is not a problem with personal loans since your payment terms are already fixed.
Should I use a credit card or take out a personal loan?
In short, it depends on your financial situation and on what you plan to do with your credit. However, with both forms of credit, you will end up in an unpleasant financial situation if you take out more than you can repay. Therefore, before you use either a credit card or a personal loan to finance your purchases, you must evaluate the impact of the loan on your financial plans.
If you fail to pay back your personal loan, your lender will likely report it to credit bureaus. Since your loan payment history accounts for approximately 35% of your credit score, reports of repayment failure will reflect poorly on your credit profile.
Credit cards are great for people who are diligent with paying back their credit on time. A credit card lets them reap cash back rewards on everyday spending and helps them build their credit scores. However, a credit card is not the best option to finance large purchases that you expect to pay back over a long period. In such cases, taking out a personal loan might be best.
In addition, both credit cards and personal loans are packaged differently by each business that offers them. You should compare the rates and fees of all your credit choices before you settle on a final product. For example, you should check for reward schemes, introductory offers, and hidden costs before getting a credit card. Similarly, it is advised that you review interest rates and personal loan terms with various financial institutions before making your next big purchase.
If you’re looking for a company that offers good interest rates and provides 1.5% cash back on all spending, sign up for early access to Vital. We are a credit card company that offers world-class customer service and unique credit rewards with no annual fee.
Sources
“Consumer Credit -G.19,” Board of Governors of the Federal Reserve System
“How Credit Card Grace Periods Work,” NerdWallet
“Focus On Payment History,” Forbes Advisor
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.