You’ll probably need to borrow money at some point in your life to cover expenses or meet certain goals. When it comes to borrowing, personal loans and credit cards are two of the more common options that people use. However, credit cards and personal loans are designed to help you take care of different financial needs.
Understanding the difference between these two borrowing options — and the pros and cons of each — can help you make the right financial decision.
Personal Loan vs. Credit Card: Which Is Better?
Deciding whether a personal loan or credit card is better will depend on your financial situation and what you plan to use the funds for. Personal loans typically offer a fixed amount of money and have a set repayment schedule. They can be great for taking care of larger expenses. On the other hand, credit cards provide you with a revolving line of credit that can be used for ongoing or smaller purchases.
While one isn’t necessarily “better” than the other, they are designed to serve different purposes and can be beneficial when used correctly. Taking the time to assess your goals, your budget and repayment ability can help you make the right choice.
What is the difference between a personal loan and a credit card?
Personal loans. Typically, personal loans offer borrowers a one-time, lump sum of money that is repaid over time. They can be used for a variety of purposes including things like consolidating high-interest debt, covering emergency expenses or funding major home improvements. These types of loans often come with fixed interest rates and a fixed repayment schedule — meaning you’ll make regular payments until the debt is paid off.
Credit cards. Credit cards are a type of revolving credit. If you’re approved by a credit card issuer, you’ll be given a set credit limit and you can charge up to that amount on the card. As you pay off the card balance, your available credit will replenish, allowing you to continue making purchases within your limit. Credit cards are good for funding smaller expenses or everyday purchases. Credit cards may also come with perks such as cash back, rewards and travel benefits. However, credit cards may also have a variable interest rate and come with annual fees.
| Personal Loan | Credit Card | |
| Funding | One-time, lump sum of money upfront | Charge your card as needed, up to the credit limit |
| Repayment terms | Fixed installments over time | Variable monthly payments |
| Interest rates | Fixed interest rates | Variable interest rates |
| Good for | Large purchases, debt consolidation | Everyday expenses |
Pros and cons of a personal loan
Pros
Predictable payments. With a personal loan, you’ll know exactly how much you need to pay and for how long.
Higher borrowing limits. Personal loans often offer access to more cash than a credit card’s credit limit.
No annual fees. While personal loans can still have fees (like an origination fee) there isn’t typically an annual fee you need to pay to maintain your account.
Cons
Less flexibility. After receiving the lump sum, it can be more difficult to borrow more. Some lenders will allow you to refinance — but you’ll have to reapply.
High interest in some situations. If you have an excellent credit score, personal loans can often have lower interest rates than credit cards. However, bad credit personal loans can come with higher interest rates.
Not ideal for small purchases. While you can use the funds from a personal loan to take care of everyday expenses, it’s not what it’s designed for and can lead to you carrying unnecessary debt.
When to use a personal loan
Personal loans can be a useful financial tool when you need to cover a large expense that might otherwise strain your budget. These loans can provide the funds you need to cover things such as emergency car repairs, home renovations, or moving. They can also be helpful when you need to handle overdue bills or consolidate high-interest credit card debt.
Pros and cons of a credit card
Pros
Flexibility. Credit cards offer you the flexibility you need to borrow what you need, when you need it.
Rewards and perks. If you have a good credit score, you may qualify for a credit card that offers rewards or perks like cash back or travel points.
Good for everyday purchases. Credit cards are frequently used to make small everyday purchases.
Cons
Eligibility for perks. Without a strong credit score, qualifying for cards that offer perks may be slightly more challenging than applying for those without them.
Fees. Many credit cards charge annual maintenance fees you’ll need to pay in order to keep your account open. Ensure you review the card’s terms to determine if an annual fee applies.
Potential to overspend. It’s easy to swipe a credit card and worry about paying it later. This can make it very easy to overspend.
When to use a credit card
Credit cards can be useful for managing smaller expenses, whether it’s a recurring charge like a subscription service or a minor unexpected expense. They provide a convenient way to cover these costs without immediately dipping into your savings, giving you the flexibility to pay them off over time.
Is a personal loan or credit card a more expensive way to borrow?
The cost of borrowing depends on several factors. This can include the borrower’s credit history, the loan amount and more. If you have good credit, personal loans can typically offer lower interest rates than a credit card. However, if you pay off your balance each month you may be able to avoid paying too much in credit card interest.
For those with lower credit scores, getting approved may be more difficult. Personal loans designed for those with bad credit may come with high interest rates. On the other hand, unsecured credit cards may be difficult to qualify for.
Can a personal loan or a credit card help my credit?
Personal loans and credit cards can help you build your credit if the lender reports to credit bureaus and you make timely payments. With a personal loan, consistent on-time payments can help you build your score. With a credit card, you can build your score by keeping your credit utilization rate low and paying on time.
Your credit score is calculated using a number of different factors. Payment history is the main factor, though credit utilization is a close second. This means that paying on time and keeping a low credit card balance can increase your creditworthiness.
You should keep in mind that missed or late payments and a high credit utilization rate will appear on your credit report and can damage your credit score.
Are there other borrowing options that may be a better fit?
Line of credit. A personal line of credit is a form of revolving credit similar to a credit card. However, instead of charging purchases to a card, you’ll take a draw and the cash will be deposited into your account. Lines of credit offer flexibility and may come with a higher credit limit than credit cards, and other fees may apply.
HELOC. If you own your home, you may qualify for a home equity line of credit or loan. These can be useful for large expenses and may come with lower rates — however your home will act as collateral.
Borrow from friends or family. Borrowing from a lender like a bank or credit union isn’t always an option. If you have friends and family who are in a position to help, it can be a good idea to turn to them instead of a financial institution. Your support network will often offer you the most favorable loan terms and they may not require you to pay interest.
DISCLAIMER: This content is for informational purposes only and should not be considered financial, investment, tax or legal advice.
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