Both offer convenient and fast access to funds, but which is the smart financial move in the long term?
Most Americans in need of a fast influx of cash will rely on credit cards due to the convenience and high credit limits. But that convenience comes with a major cost. Credit cards are one of the most expensive forms of financing and usually come with interest rates in the double digits (if your credit score isn’t stellar).
Personal loans have lower interest rates and are paid back in installments, over a specified period of time (usually 3-72 months). They require an application process and approval from a loan provider, which can be done completely online.
So when should you rack up a charge on your credit card and when should you apply for a personal loan?
When to use a credit card:
The general rule is that credit cards are best for short-term financing - such as monthly bills or small, daily purchases - that you can pay off by the due date. Credit cards can be paid off in monthly installments by making a minimum monthly payment (1-3% of the balance) but unless the bill is paid in full you will continue to accrue high interest on the remaining balance.
This high interest rate explains why one of the most common reasons for taking a personal loan is to consolidate and pay off credit card debt. The interest rate on a personal loan (depending on your credit score) is usually lower than that of a credit card, which essentially allows you to swap out a high interest credit card bill for a lower interest loan.
When to apply for a personal loan:
Personal loans tend to be smaller than bank loans, rarely exceeding $50,000 and can be secured (collateral needed) or unsecured. If you’re approved for a loan, you receive a lump sum which is repaid over a predetermined period.
Personal loans are a great option if you want to consolidate debt, especially credit card debt and student loans. Credit card interest can be as high as 15%, while interest on personal loans can be as low as 2.5%.
Here are 4 things to consider when looking for a personal loan:
1. What are the repayment terms?
Many online lenders and loan marketplaces, such as LendingTree, offer loan calculators to help borrowers properly budget and understand how much money they will have to pay back over the lifetime of the loan. Make sure you can keep up with the loan repayment terms and get a clear picture of what you’re agreeing to.
LendingTree Loan calculator >>
2. How badly do I need the funds?
Interest rates on personal loans differ by credit score. So if you have less than stellar credit and are looking to make a non-essential purchase, it might be best to hold off and work on repairing your credit before taking out a loan. The difference in interest rates can add up to hundreds of dollars over the life of the loan. If it’s something more urgent, or if the money will be used to pay off other high interest bills, make sure you shop around and get quotes from a number of online lenders.
AmOne is another loan marketplace that is ideal for borrowers with fair credit who need funds fast. One application will connect you with over 100 lenders.
3. Should I go with a fixed or variable interest rate?
With a fixed rate loan, the interest rate remains the same over the lifetime of the loan. This allows you to properly budget and ensure you can make the monthly payments. However, with a fixed loan there’s no option to pay off the loan early.
With a variable rate, the interest rate of your loan adjusts as the market interest rates change. You also have the option to pay off the loan early, which means deciding between the two usually comes down to how fast you think you’ll be able to pay back the loan.
4. Secured or unsecured loan?
Unsecured loans pose less risk to the borrower (you don’t need to put up collateral) but the price for this is that lenders will charge a higher interest rate to compensate for the more risky investment. Secured loans require collateral, and lenders will usually approve higher loan amounts if the loan is secured. The choice here depends on the loan amount you want, and if you’re willing to put up collateral.
Taking out a personal loan has its advantages - especially if you’re using it to consolidate debt or pay off high interest credit cards. But be sure to get funding from a trusted lender, read the fine print, and understand the repayment terms.
Need help finding the right personal loan? Answer 5 questions to get matched with the right lender.