When unexpected expenses arise or you simply need a little extra financial flexibility, two common options come to mind: personal loans and credit cards. Both can be handy tools for covering small expenses, but each comes with its own set of advantages and drawbacks. Personal Loan vs. Credit Card, which one should you choose?
Let us look at the differences between personal loans and credit cards to help you determine which is better for small expenses. There are several factors you need to know before you decide which best suits your situation. Come on let us get down to learning.
What is a Personal Loan?
A personal loan is a fixed, lump-sum amount borrowed from a bank, credit union, or online lender. You receive the funds upfront and repay the loan in fixed monthly instalments over a predetermined period. Most personal loans have a fixed interest rate, which means your monthly payments remain the same throughout the loan term.
What is a Credit Card?
Credit cards, on the other hand, offer a revolving line of credit. You can make purchases up to your credit limit, and the amount you owe fluctuates as you use the card and make payments. Credit cards have variable interest rates, which means the interest you pay can vary based on your balance and the card’s terms.
The Pros and Cons of Personal Loans
Pros of Personal Loans:
- Fixed monthly payments make budgeting easy.
- Personal loans often have lower interest rates compared to credit cards.
- Loan terms can extend for several years, allowing for smaller monthly payments.
Cons of Personal Loans:
- Getting approved for a personal loan may involve a credit check and documentation.
- Some lenders charge origination fees, which can add to the overall cost of the loan.
The Pros and Cons of Credit Cards
Pros of Credit Cards:
- Credit cards offer flexibility for small, ongoing expenses.
- Most people already have a credit card, making it readily available.
- Many credit cards offer rewards, cashback, or other perks for cardholders.
Cons of Credit Cards:
- Credit card interest rates can be significantly higher than personal loan rates.
- Minimum Payments: Paying only the minimum can lead to long-term debt and substantial interest charges.
- Temptation to Overspend: The ease of using a credit card can lead to impulse purchases and higher debt.
Key Differences Between Personal Loans and Credit Cards
Personal loans and credit cards both provide access to credit, they differ in several key ways. Here are the key differences.
|Personal Loan||Credit Card|
|Loan Structure||Personal loans provide a fixed, one-time lump sum amount upfront||Personal loans provide a fixed, one-time lump sum amount upfront|
|Interest rates||Personal loans have fixed interest rates.||Credit cards have variable interest rates.|
|Payment structure||Monthly payments on personal loans are fixed, consisting of both principal and interest.||Credit cards require a minimum payment, often a percentage of the outstanding balance|
|Borrowing flexibility||Personal loans are best suited for specific, planned expenses, such as home renovations, car purchases, or debt consolidation||Credit cards are designed for ongoing, smaller expenses and everyday purchases.|
|Approval Process||Obtaining a personal loan involves a more formal approval process||Many people already have credit cards, so there’s no need for a separate approval process.|
|Credit Utilisation||Personal loans provide a fixed amount of credit, this doesn’t affect utilisation.||Credit card balances contribute to your credit utilization ratio|
|Credit Score||Credit card balances contribute to your credit utilization ratio||Responsible use of credit cards, including making on-time payments and keeping your credit utilization low, can positively influence your credit score|
How to Compare Personal Loan vs. Credit Card
Before you decide which of these two financial tools you want to sign up for, consider the following,
One of the key factors in choosing between a personal loan and a credit card for small expenses is the interest rate. Personal loans typically offer lower interest rates than credit cards. This can make personal loans more cost-effective if you need to borrow a larger amount or if you anticipate needing several months to pay off the expense.
Credit cards, while convenient, often come with higher interest rates. These rates can quickly add up if you carry a balance from month to month, especially if you only make the minimum payment.
Another important consideration is how you plan to manage your debt. If you’re disciplined and confident in your ability to make fixed monthly payments, a personal loan might be the better choice. With this approach, you have a set schedule for repaying the debt, and you won’t be tempted to continue spending.
On the other hand, if you have the self-control to use a credit card responsibly, it can be a convenient way to handle small, short-term expenses. The key is to pay off your credit card balance in full each month to avoid accumulating high-interest debt.
Impact on Credit Score
Both personal loans and credit cards can affect your credit score. A personal loan adds an installment account to your credit history, which can have a positive impact on your credit score if you make timely payments. However, missing payments can harm your credit.
Credit cards, when used responsibly, can also boost your credit score. They contribute to your credit utilization ratio, which is the amount of credit you’re using compared to your total credit limit. Maintaining a low credit utilization ratio by not maxing out your card can have a positive effect on your credit score. But, excessive credit card debt and missed payments can negatively impact your credit.
Personal Loan or Credit Card: Which is Better for Small Expenses?
The choice between a personal loan and a credit card for small expenses depends on your financial situation and spending habits:
- Choose a Personal Loan If:
- You need a fixed amount of money for a specific expense.
- You prefer fixed, predictable monthly payments.
- You want to take advantage of lower interest rates.
- You can qualify for a personal loan with reasonable terms.
- Choose a Credit Card If:
- You have the discipline to pay off your balance in full each month.
- You require ongoing, smaller expenses with a revolving line of credit.
- You want to earn rewards or cashback on your purchases.
- You need a readily available source of credit.
Tips for Using Personal Loans and Credit Cards Wisely
Regardless of which option you choose, here are some tips to use personal loans and credit cards wisely:
- Create a budget to understand your financial situation and how the loan or credit card fits into it.
- Shop around for the best terms and interest rates on personal loans.
- Choose a credit card with a competitive interest rate and consider rewards or cashback features.
- Make timely payments to avoid late fees and negative impacts on your credit.
- Pay more than the minimum due to reduce debt and interest costs.
- Avoid borrowing more than you can comfortably repay.
In the battle between personal loans vs. credit cards for small expenses, your choice should depend on your individual financial situation. Personal loans offer structured, fixed payments and lower interest rates, making them ideal for larger, planned expenses. Credit cards provide flexibility and rewards but come with higher interest rates, making them a suitable option for smaller, short-term expenses if you can pay off the balance in full each month.
Before deciding, carefully consider your options, compare interest rates, and assess your ability to manage debt wisely. With the right choice and responsible financial habits, you can effectively handle small expenses while keeping your financial future on track.