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Personal Loan vs. Credit Card: How to Decide Which Is Right For You

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If you’re like most Americans, credit cards are your go-to option when you need a little extra cash. Studies show the average American adult has four credit cards totaling over $6,000 in credit card debt. While they may be convenient, carrying large credit card balances from one month to the next over long periods of time is often not the best financial decision. In many cases, using a personal loan instead of a credit card can offer surprising benefits and savings—such as fixed monthly payments, larger loan amounts, and lower interest rates—especially if you’re not able to pay off your balance in full each month.

The problem is most people aren’t aware of their options when it comes to personal loans. We’re making navigating it all easier with our guide for personal loans vs. credit cards—helping you decide which is the right fit for you.

How a Credit Card Works

A credit card is like a line of credit—a preset amount of money that can be tapped into at any time, and repaid either immediately or over time. Your interest rate on a credit card is listed as an "annual percentage rate" (APR) and is commonly variable, meaning the rate can change over time. Many credit cards also have introductory offers which may give you lower interest rates for a certain period of time, typically 12 to 18 months, at which point rates can increase substantially. Ideally, at the end of each billing cycle you would try to repay the full amount used (borrowed), or you will begin accruing interest charges on the outstanding balance.

If you’re not able to pay off your balance in full each month, you will be required to make a minimum payment—typically, 1% to 3% of your balance—toward your total (including any accrued interest). Failure to make these payments will result in late fees, and will negatively impact your credit score.

Credit cards are generally easy to obtain and tend to be one of the first ways individuals begin to build a credit history. Not only is a credit card an easy way to access cash, it also can have a big influence on your credit score. Using too much of your available credit limit, or missing a minimum monthly payment, can result in a lower credit score, affecting your ability to access other types of loans, most notably a mortgage.

When Is a Credit Card Right For You?

There are many times when a credit card is a good and convenient option. These scenarios tend to be for small, less predictable purchases over the short term. Here’s a couple markers for when using a credit card is a good idea.

You need to finance smaller expenses.

If you’re buying holiday gifts or summer travel plans, and just need a little extra cash to smooth out an increase in short-term spending, credit cards are an appropriate choice. Once you’re approved for your credit limit, you can spend instantly, so no need to worryhaving cash available when you need it.

Your card has a rewards program.

Many cards include points or cash back for spending on certain categories such as dining or travel. If you can afford to pay off your balance in full each month, using a credit card allows you to earn extra cash while spending.

You’re unsure what the money's for or when you'll need it.

Above all, credit cards are valued for their flexibility. If you want to cushion your savings against sudden emergencies or unplanned spending, having a credit card handy can be useful in a pinch.

How Much Does Your Credit Card Really Cost You?

The true cost of a credit card is measured by its annual percentage rate (APR), which includes interest rate and associated fees. Although widely-accepted and easy to use, credit cards actually tend to have higher interest rates than other forms of debt, with an average national APR of 16.01%.

If you can’t afford to pay off your credit card bill in full, you’ll start to accrue interest on your outstanding credit card balance. This means the amount you owe will continue to grow—even if you stop using your card for new purchases. Furthermore, your balance faces compounding interest, meaning you’ll pay interest on your purchases as well as interest on the unpaid interest. As a result, paying only the minimum amount required can be a recipe for spiraling into deeper debt. Paying off your balance in full every month is the healthiest way to use a credit card, as it will eliminate interest charges (however you may still have to pay annual fees).

> Pro Tip: How much is your credit card costing you? Plug your existing credit card debt into this easy online calculator.

What Is a Personal Loan?

A personal loan is a lump sum of money you can borrow for almost any purpose, such as consolidating credit card debt, paying off medical debt, or making home improvements. A personal loan is paid back at a fixed interest rate through set monthly installments over a predetermined repayment schedule.

With a personal loan, you are borrowing the entirety of the lump sum (regardless of whether you use it all), whereas a credit card acts like a credit line, where you pay only for funds you use.

When Is a Personal Loan a Good Option?

Personal loans are favorable financing options for situations involving large purchases that you need to pay off over time, as they typically offer lower rates and larger limits than credit cards. Here are some common uses:

You want to consolidate credit card debt.

As mentioned earlier, credit cards tend to carry high interest rates relative to other borrowing options. According to Experian, the average personal loan interest rate was 9.41%—almost half the reported average of 16% for credit cards. So, for many individuals who can secure a large loan amount, using a personal loan is a great and inexpensive option for debt consolidation.

You need a large amount of money.

Generally, a personal loan will often give you access to more cash than a credit card. Through LendingClub, for example, personal loan amounts range from $1,000 up to $40,000. Whereas with credit cards, while limits may vary by age and location, the average American carries an average limit of $31,015 across all the credit cards they hold, according to the latest 2019 Experian data. Having access to a higher loan amount makes personal loans a good fit for financing large medical bills, and home repairs and improvements—the kind of expenses and purchases that will take more than a couple of months to pay back.

You prefer a fixed interest rate.

If you want to know exactly how much you will be paying each and every month, and want a set loan payoff date, personal loans may be preferable over credit cards.

You want flexible access to your cash loan amount.

Personal loans offer additional flexibility in how you can access and disperse your funds. Funds usually are deposited directly into your designated bank account. With the money now in hand, you can quickly and easily pay workers in cash, write a check to a contractor, or transfer money via EFT to pay down outstanding medical bills or credit card debt. And while some credit card companies will allow you to take out a cash advance against your credit limit, you'll also wind up paying a hefty fee.

Personal Loan Fees and Penalties

Although personal loans tend to have lower interest rates than credit cards, some may also come with other costs, primarily in the form of origination fees and prepayment penalties.

An origination fee is the cost associated with setting up the loan by your lender. Origination fees typically range anywhere from 2-6% of the total loan amount.

A prepayment penalty is a fee for paying off the remainder of your entire loan amount before the due date specified in your loan agreement. The reason for this is lenders calculate your total amount due (your principal plus interest) upfront, so deviating from the schedule can often leave them at a loss from their original projections.

Not all lenders have origination fees or prepayment penalties, but they may make up for it by charging you a higher interest rate.

> Pro Tip: Before signing up for a personal loan through a lender, make sure you understand their fees, if any. Costs vary by lender and you can save by comparison shopping.

Personal Loan vs. Credit Card: Which Should You Choose?

Because everyone’s financial situation is different, there’s no one-size-fits-all answer to whether a personal loan or a credit card is right. A quick way to analyze which option might work best for you is to ask yourself these three questions:

Do you know what you need the money for?

If you don’t have a specific project or purpose in mind, or a timeline for when you’ll need the money, it’s probably better to consider a credit card over a personal loan. The reason for this is that you pay a credit card balance based on what you borrow, whereas a personal loan is a lump sum borrowed upfront that you’ll need to start paying back immediately, whether or not you start using the funds right away. On the flipside, if you know exactly how much you need, and for how long, you can generally expect to secure a lower interest rate through a personal loan versus a credit card.

Will you pay off your credit card balance every month?

As a general rule, if you’re able to pay off your balance each month, the right credit card can offer many advantages. With many cards, you not only have convenience, but purchase protection, membership perks, select warranties, and travel and cash rewards. Not to mention, consistently paying your balance in full each month guarantees you never have to worry about the added costs of accrued interest.

How does your credit score affect your interest rate?

The interest rate you’re offered on both personal loans and credit cards depends largely on your credit history. If you have a good credit score, low credit utilization, and a history of paying bills on time, you’ll likely qualify for the lowest rates. While past financial problems like late payments or collection accounts can lower your credit score and lead to a higher interest rate.

However, you may be offered a lower rate if you opt for a secured loan. A secured loan is backed by an asset, such as your home or car. If you default on the loan, the lender may be able to take possession of your asset. Since this makes your loan less of a risk, you may be able to get a lower interest rate, even with past credit blemishes.

Debt Consolidation vs. Balance Transfer Credit Card

Arguably the most common situation where an individual will directly compare a personal loan to a credit card is when consolidating multiple, existing high interest credit card debt into one single account and payment, and at a lower average rate. There isn't an easy answer to whether a debt consolidation loan or a balance transfer credit card is the better option for this, but you can get a good idea by comparing costs for each.

Many balance transfer credit cards feature a 0% interest rate for a short period of time (typically, 12 to 18 months). If you know you can knock out your debt before the promotional period expires, you’re in a position to save massively on interest costs. However, balance transfer credit cards often have a one-time balance transfer fee, usually between 3-5% of the amount transferred. This fee applies even if you’re also being offered a low introductory interest rate. So be sure to factor in all associated fees, interest, and other costs into your comparison.

If you don't qualify for a balance transfer credit card, or know you'll need a few years before paying down the debt you've accumulated, a balance transfer loan could be a good option. A balance transfer loan is a type of personal loan that offers great value in consolidating multiple debts, often at lower rates. In addition to the savings and convenience of one single, easy-to-manage payment, choosing a balance transfer loan can help increase your credit score over time. For example, on average, many LendingClub members with balance transfer loans see an increase in their credit score while saving each month.1

The Bottom Line

When evaluating a personal loan versus a credit card, you'll want to consider what loan amount you need, compare interest rates, examine and calculate in any fees, and weigh the flexibility and/or convenience of each. Whichever way you go, thoroughly research the credit cards that meet your needs, or conversely, comparison shop online lenders for the most competitively priced personal loan. And, as with all types of debt and borrowing, we always recommend doing what you can to get a good credit score which can help you land a better rate either way.

1On average, borrowers who paid their debt down and maintained low balances saw a credit score increase; however, other factors including increasing debt load could result in your credit score declining.

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