Credit cards and personal loans are two popular financing options. However, they have very different features and are usually best suited for different situations.
Credit cards can be useful in emergencies, and you can earn rewards with them over time. Personal loans, on the other hand, are great for debt consolidation and major expenses.
When deciding whether a credit card or personal loan is right for you, it’s important to consider what you need the money for, the pros and cons of each option, and the alternatives that may be available.
A credit card is a revolving line of credit that you can use as much as you want, up to the credit limit for that card. However, you can only use the amount available on the card at any time. You’re generally required to repay only a small amount (known as the minimum payment) each month. But credit cards have high annual percentage rates (APRs) — the interest rate plus any fees — and interest will continue to grow on any unpaid balance.
A personal loan is an installment loan. You receive a lump sum of money after approval and then pay it off over a set loan term (usually up to a maximum of seven years). Personal loans aren’t a form of revolving credit like credit cards, so if you need more money, you must take out a new loan.
Credit cards and personal loans can often be used in similar situations, but each is better for certain purposes. Here’s a quick side-by-side comparison of the two:
| Credit card | Personal loan | |
|---|---|---|
| Revolving credit? | Yes | No |
| Repayment terms | None; must make at least a minimum monthly payment | Several months to several years |
| Average APRs | 20.09% | 11.48% |
| Fixed or variable rates? | Variable | Typically fixed |
| Common fees | Annual fee Late fee Card replacement fee Balance transfer fee Returned payment fee Foreign transaction fee Over-limit fee Cash advance fee | Origination fee Documentation fee Late fee Prepayment penalty |
A personal loan is a popular tool for situations when you need to borrow a large sum of money. You can also use a personal loan for debt consolidation — this is when you take out a loan to repay all your high-interest debts. With this option, you typically benefit from a lower interest rate, and you only have one monthly debt payment to manage. Personal loans can also be used for unforeseen medical bills, home renovations, and expensive purchases.
However, if you only need to borrow a few hundred dollars, a personal loan may not be the best option — most personal loans have minimum amounts of $1,000 or more. Personal loans also generally have stricter eligibility requirements than credit cards, so you may not qualify for a loan. In this case, a credit card may be a better option.
A personal loan can affect your credit in several different ways. Applying for a personal loan triggers a hard credit check, which can cause your credit score to drop. However, it’s usually only a five-point decrease, and it may only affect your credit score for a few months to a year.
Once you take out a personal loan, it’ll appear on your credit report as a new account. This can have a negative impact on your credit score since it lowers the average age of your accounts, which makes up 15% of your FICO credit score. But it could also help your credit by diversifying your credit mix, which accounts for 10% of your credit score.
Finally, a personal loan can help your credit score in the long run if you make consistent on-time payments. Your payment history makes up the biggest part of your FICO credit score at 35%.
While credit cards can be used for large purchases like a personal loan can, they’re not as well-suited to that purpose because of high-interest rates.
Instead, credit cards are often better for day-to-day spending as a way to earn rewards, like airline miles. When using a credit card for this purpose, it’s best to pay it off each month to avoid paying interest.
In other cases, a credit card may be a good option for last-minute financial emergencies. If you just need a little bit of money to tide you over, and know you can repay it by your card’s due date, a credit card can be a good solution.
You may be able to qualify for a card with a 0% APR introductory period — this means you don’t have to pay any interest on the card for a predetermined amount of time. If you’re able to pay off the card balance before that period ends, you can save money on interest.
Credit cards can impact your credit report similarly to how personal loans do when it comes to new credit, your credit mix, and your payment history. However, they can also have a huge impact by affecting your credit utilization.
Your credit utilization is the percentage of your revolving credit you’re using at any one time. Higher credit utilization can cause your credit score to go down, since it can indicate that you’re overextended. It’s generally best to keep your credit utilization below 30%. To calculate your credit utilization ratio, divide your total credit card debt by your total credit limit. If you have two credit cards, each with a $1,000 limit, and you’re using $1,300 across both cards, your credit utilization ratio would be 65% (1,300/2,000 = 0.65).
When you need access to cash, you don’t have to use credit cards or personal loans. Here are some other options: