When it comes to financing your personal needs, credit cards and personal loans are the most commonly used options. While both of them offer a smart way to cover various expenses or finance life events, they come with significant differences in the way they work and need to be repaid. Therefore, they are typically used for different financial goals and situations. Here's a detailed look at each option and a comparison analysis to help you make an informed decision.
A personal loan is a form of borrowing where an individual gets a lump-sum deposit that can be used for any personal needs without restriction. The amount obtained is subject to an interest rate, which is the cost of borrowing the lender charges. Once a borrower gets a loan, they start to repay what they owe in fixed monthly or bi-weekly installments within a predetermined period.
Personal loans usually don't require collateral, so you don't need to provide any valuable assets to back your application. The amount a borrower can get is usually up to $100,000. The exact sum is determined based on an applicant's income, credit score, and the repayment period chosen. The period is usually between 12 and 84 months. The longer the period, the lower the monthly payment. At the same time, it also results in more overpayment over the loan lifespan.
To apply for a personal loan, a borrower needs to provide a set of documents to verify their identity, residence, income, and employment. A lender will also assess an applicant's credit report details, paying special attention to the payment history and credit scores. Based on the data provided, a lender makes an approval decision and decides on the interest rate they can offer. On average, personal loans cost between 5.99% and 35.99% annually.
The application process may be either completed online or in a store, depending on the lender. Online lenders usually offer faster and more flexible options but may also set higher APRs. In-store borrowing usually involves more documentation and a longer overall process but often comes with more favorable loan terms.
Before approval, a lender performs a credit check (can be either soft or hard) and notifies you about the decision made. If approved, the funds are usually deposited into a borrower's bank account within 1 to 5 business days. The repayment is then made based on the repayment schedule, often via automatic payments.
Personal loans offer both strong and weak points. Here are some features to be aware of.
Pros:
Convenient loan amounts: borrowers can obtain between $1,000 and $100,000, making the loans suitable for a wide range of personal needs;
Repayment flexibility. You can choose a shorter or longer repayment period to adjust your loan payments to your budget;
Relatively low interest rates: APRs typically range from 5.99% to 35.99%, making personal loans quite affordable. This is especially true for good credit borrowers;
Predictability. As APRs are fixed, your monthly payments don't change over the loan life, either. This makes it easier to budget;
No collateral is needed. You can borrow money without any repayment guarantee, which possesses less risk.
Cons:
Extra fees may be applied. Personal loans often come with additional charges for processing, late payments, or prepayment, which may affect the total cost;
Good credit is required. Most conventional personal loan lenders require a minimum credit score of 670 to qualify. Options for borrowers with lower scores exist but may come with unfavorable loan terms;
Don't suit your short-term needs. A personal loan is a long-term debt. This also means you will pay more interest in the long run;
Long approval and funding times. As most lenders perform hard credit checks to evaluate an applicant's creditworthiness, approval may take several business days. Upon approval, money transfers may also take from 1 to 5 business days;
Impact on a borrower's credit score. A hard credit check will typically lower your credit rating by a few points. Late or missed payments may have a further impact on your credit profile.
A credit card loan is a revolving form of debt, meaning that a borrower can use money within a certain limit, repay it, and then use the same sum again. Interest is typically paid only on the amount a borrower actually uses. This makes credit cards a great option for people who need money occasionally and want to always have access to funds when needed.
Credit cards come in the form of a particular line of credit, which may range from a few hundred dollars to $100,000 (still, the most typical maximum is $10,000 to $25,000). Once you get your plastic, you can use it to pay for purchases in any stores that accept credit card payments. The amount you use is added to your outstanding balance, which represents your total credit card debt.
The repayment can be made in two ways. A borrower can either repay what they owe in full by the end of the billing cycle without accruing any interest or make just minimum payments and be charged interest for an outstanding balance. Credit card interest rates are usually between 18% and 30% and are variable. This means that an APR can change over time under certain market conditions.
There are also credit cards with a trial 0%-APR period. Such cards still require you to make a minimum monthly payment but won't charge any interest on the outstanding balance within a certain period, usually 6 to 21 months. After the period ends, you will be charged interest on the entire unpaid balance.
Credit cards can be obtained from banks, credit unions, and online lenders. Additionally, there's a wide range of credit cards available to borrowers with less-than-perfect credit scores. This form of debt also offers various rewards and cashback options, so you can benefit from using it wisely.
Let's take a look at the key advantages and drawbacks of credit cards.
Pros:
Convenience. A credit card gives you the ability to buy the stuff you need when you need it, eliminating the need to save money for it over a long period;
Flexibility. You can only make a minimum payment when your budget is tough;
Potentially 0% financing. If you manage to repay your balance within a billing cycle (usually a month), there will be no interest charged on the amount used;
Perks and rewards. Many issuers offer the ability to earn cashback from your credit card purchases or offer various rewards in hotel or airline points;
Credit-building opportunities. Responsible credit card usage can improve your credit score and shows lenders you can maintain this form of debt with ease.
Cons:
Higher interest rates. Minimum credit card APRs are usually higher than those on personal loans;
Unpredictability. Most credit cards have variable rates which can change unexpectedly, potentially increasing the cost of your debt;
Impact on your credit score. Credit card debt affects your credit rating as it impacts your credit utilization ratio. There may also be a drop if you fail to make at least your minimum payment on time;
Risk of overspending. As your credit line will always be as close as your wallet is, it's easy and even tempting to make impulse purchases and indulge in your bad financial habits;
Fees. Credit cards may apply extra fees for money withdrawals or annual maintenance.
The table below demonstrates the major differences between personal loans and credit cards:
|
Feature |
Personal Loans |
Credit Cards |
|
Loan Amounts |
$1,000 to $100,000 |
$50 to $25,000 o $100,000 in a form of a revolving credit line |
|
APRs |
5.99% to 35.99% (fixed) |
18% to 30% (variable) |
|
Repayment Terms |
12 to 84 months. A borrower makes fixed monthly or bi-weekly payments within the loan life |
Revolving credit. You may only make a minimum payment, which is calculated based on how much money you have used. Interest will accrue on your outstanding balance |
|
Minimum Credit Score |
Good credit (670 or higher) is usually needed |
Usually no less than 580, but there are credit cards for almost any credit |
|
Credit-Building Opportunities |
Helps build credit by making on-time payments |
Helps build credit by making on-time minimum payments and maintaining a credit utilization ratio of no more than 30% |
|
Disbursement |
Usually takes 1 to 5 business days of approval |
A few days to a month, depending on the lender. Once you already have a card, you can use it when needed |
The choice should be made based on your loan purpose and current financial situation. Personal loans suit people who need to make big purchases, cover significant expenses, or finance major life events. Here are the most common personal loan uses:
Medical bills;
Home improvement;
Debt consolidation;
Vacation expenses;
Wedding financing;
Funeral expenses;
Big purchases.
Credit cards are mostly designed for daily expenses and unexpected costs that need to be covered quickly. Therefore, they are usually used in the following situations:
Day-to-day spending (fuel, groceries, etc.);
Emergency expenses;
Paying for accommodation and air tickets;
Seasonal expenses (buying presents or school supplies).
There are several alternatives you can consider if you need extra financing, but none of the options considered suits you ideally:
Secured loans offer financing against a borrower's valuable assets by using the item as collateral. You may pledge a car, a house, a savings account balance, or your crypto holdings to secure much-needed financing. In most cases, you'll get a portion of the item's cost. If something goes wrong and you default on the loan, a lender can repossess your asset. As secured loans are less risky for loan providers, they usually have lower interest rates and can be obtained with less-than-perfect credit.
An emergency loan is a small, short-term loan that provides same-day or next-day financing in case of urgent needs. Such loans are usually due to a borrower's next paycheck and need to be repaid in full. Besides their speed, they are known for being very accessible. This is because lenders offering them are not very focused on a consumer's credit score. Instead, they evaluate their financial situation and payment history to determine the likelihood of getting their money back. However, such loans come with very high APRs, often exceeding 400%.
A home equity loan is a type of secured loan that uses the equity that a borrower owns in their house as collateral. Equity is your house's cost minus what you still owe on your mortgage. A customer can get up to 85% of this figure in one lump sum. The repayment is then made in equal monthly payments within 5 to 15 years. A home equity loan APR is typically between 8% to 10% (usually fixed). Still, you need to assess all the risks associated with late payments or loan defaults. If you become unable to pay on time, a lender may seize your house and use it to cover the debt.
A home equity line of credit (HELOC) is a combination of a home equity loan and a credit card. With its help, you can get up to 80-85% of your home's equity by using it as collateral. Instead of getting a lump sum deposit on hand (like with a home equity loan), you will get a credit line you can use from time to time when needed. Interest will apply only to the amount you actually use. An APR on such a line of credit ranges between 8 to 13% (usually variable).
A HELOC repayment period consists of 2 phases:
A draw period. It may be up to 10 years. Within this period, you can use the funds and are allowed to make only interest payments. Paying off the loan principal is optional.
A repayment period. This period lasts for up to 20 years. When the repayment starts, you can't access your credit line anymore and must repay both interest and principal in equal monthly payments.
If you have a current mortgage, consider refinancing with a larger loan. This will allow you to get the amount remaining after repaying your mortgage on hand. Then, you can use this sum to cover any needs you have. Most people spend the funds on home renovation projects, but there are usually no restrictions. Cash out refinance often has rates between 5% and 7%, so you can potentially save money on interest if you qualify for a loan at a lower APR compared to your current mortgage.
If you need money for something specific, such as a car or a house, or education, check out whether there are specialized options. Student loans, auto loans and mortgages usually come with more favorable loan terms and lower APRs, reducing the financial burden.
Both credit cards and personal loans are frequently used to cover various individual needs. Still, they work differently and usually suit different life projects. Before you decide on a type of debt you need, consider both options thoroughly and match their features with your situation and needs.
Some lenders offer bad credit personal loans for borrowers who have steady income. Still, these options are usually more expensive due to higher APRs. You may also face loan amount limits and shorter repayment terms. Improving your credit score is advisable to get favorable loan terms.
There are multiple credit card issuers that offer lines of credit to people with any ratings. However, just like with bad credit personal loans, your borrowing terms will most likely be worse. This may come with higher APRs and fees and lower borrowing limits.
Personal loan APRs are from 5.99% to 35.99%. Credit card interest rates are usually 18% to 30% per annum. Just note that extra costs and fees for processing, late or early payments, withdrawals, and annual maintenance can be applied.
Most personal loans come with maximum amounts of $50,000 or $100,000. However, it also depends on your income and creditworthiness, as well as the state you live in.
Most credit cards come with limits between $50 and $25,000. Some cards may offer up to $100,000 financing but such a limit requires a very high income.
Personal loans are repaid in fixed installments on a monthly or bi-weekly basis. Most lenders offer automatic payments. This way, the money will be withdrawn from your bank account automatically on the predetermined date.
Credit card debt is often repaid manually by a borrower as the amount due often changes from month to month. However, you can still set up auto pay and automate the process.
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