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- Credit cards offer perks such as flexibility, rewards, and bonuses, but can make it easier to spend.
- Personal loans allow you to get cash upfront and spread out the cost of your borrowing over time.
- Personal loans have lower interest rates than credit cards and have a structured repayment plan.
Introduction
When looking to borrow money, you might consider either taking out a credit card or a personal loan.
Choosing the right financing option
Credit cards are more prevalent in the financial space — but they aren't the only way to get access to money. Personal loans are a less immediate, but often less risky, line of credit. There's absolutely a time and place for using credit cards, but sometimes, personal loans are the better option of the two.
Understanding personal loans
Definition and key characteristics
A personal loan is a lump sum loan in which you'll receive your money all up front, and then pay it back often over the course of several years.
Typical terms and interest rates
For large purchases that don't have such convenient financing options, like a medical procedure, car repairs or a home renovation, a personal loan will give you a lump sum of cash. You know exactly how much you will have to pay back each month, you know how much will go to interest and how much will go to the principal, and you know the exact date you will be done paying.
"The ideal reason to use a personal loan over a credit card is when you need to make a major purchase that could use up half or more of your available card credit and you don't plan to pay off the balance right away," says Michael Cetera, formerly a Senior Credit Analyst at FitSmallBusiness.com. "Putting this level of expense on your credit card could have a negative impact on your credit score."
"Generally speaking, installment loans (personal loans, mortgages, car, or student loans, etc.) are more favorable for your credit than revolving debt (lines of credit and credit cards)," says Lauren Anastasio, a financial planner at Vanguard."Installment debt is deemed less risky than revolving debt. Having installment debt on your credit history can actually be helpful in boosting your score."
Understanding credit cards
Definition and key features
A credit card is a revolving form of credit, meaning you can borrow up to a certain spending limit and then "replenish" that limit by paying down your card's balance.
Revolving credit and variable interest rates
Splurges like new computers, furniture, or upgrading your mattress can cost more money than you might have on hand. However, many retailers will offer financing through a store credit card with a sweet 0% intro APR — an opportunity you should definitely take seize if you know you'll pay the full balance within the introductory period.
However, the higher interest rates on revolving credit card balances are a huge downside to financing major purchases on a credit card. If you know that you won't be able to pay off a balance for a long time, financing a purchase on a credit card will cost much more money in the long run than it would to pay for it using a personal loan.
"A heavily weighted factor when it comes to your credit score is your utilization ratio, which is the percentage of credit you have outstanding relative to the total amount of credit available to you," says Lauren Anastasio. "Carrying a large balance on a credit card, regardless of interest rate, will likely jack up your utilization ratio, which can dramatically lower your credit score."
Key differences
Repayment terms
Credit card repayment is based on the current balance held, which can grow based on your spending and on interest for an unpaid balance. There is a minimum payment each month to cover interest charges. You can take as long as you want to pay off a credit card balance, but the longer you take, the more interest you pay.
Impact on credit score
Taking out a personal loan will make a ding on your credit score when your lender conducts a hard inquiry, but it will quickly come back up to its previous number if you make regular payments. However, revolving debt on your credit card, especially approaching 30% or more of your total available credit, can drag your score down and keep it there until you start to pay it off.
Pros and cons
Pros and cons of personal loans
| Pros | Cons |
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Personal loan lenders
Some of the best lenders that offer personal loans include:
- LightStream
- SoFi
- Avant
- PenFed Credit Union
See our guide to the top low-interest personal loans »
Pros and cons of credit cards
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Top credit card issuers
Some of the best lenders that offer credit cards include:
- Best Wells Fargo credit cards
- Best Chase credit cards
- Best Capital One credit cards
- Best American Express credit cards
FAQs
Which option offers lower interest rates, personal loans or credit cards?
Personal loans often have lower fixed-interest rates compared to the variable rates of credit cards, making them the more cost-effective choice for long-term borrowing.
Can I use a personal loan for anything, similar to a credit card?
Yes, personal loans provide a lump sum that can be used for various purposes. They offer more flexibility, similar to credit cards but without the same ease of repeated use.
How can choosing between a personal loan and a credit card affect my credit score?
Personal loans may help with credit mix and installment payment history, while credit cards affect utilization ratios and payment history.
Are there situations where using a credit card is more advantageous than a personal loan?
Yes. For short-term financing or smaller purchases that can be paid off quickly, a credit card might be more advantageous, especially if you can take advantage of interest-free periods.
Is it easier to qualify for a personal loan or a credit card?
Qualification depends on various factors, including your credit score and financial history. Credit cards might be easier to qualify for with smaller credit lines or with higher interest rates, while personal loans have a more stringent approval process for larger amounts.
Dustin Clendenen is a Los Angeles-based writer focused on personal finance, social impact and technology. His work has been published in Yahoo! Finance, Overture Magazine, LA Weekly, Upworthy, and Elephant Journal. Learn more atwww.DustinClendenen.com.
Loans Reporter
Ryan Wangman was a reporter at Personal Finance Insider reporting on personal loans, student loans, student loan refinancing, debt consolidation, auto loans, RV loans, and boat loans. He is also a Certified Educator in Personal Finance (CEPF).In his past experience writing about personal finance, he has written about credit scores, financial literacy, and homeownership. He graduated from Northwestern University and has previously written for The Boston Globe.
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