Credible takeaways
- Personal loans are a type of installment loan, while credit cards are a form of revolving credit.
- Credit cards and personal loans assess interest differently, which can make a credit card more expensive.
- Credit cards have higher APRs than personal loans, on average.
Personal loans and credit cards are both debt instruments that can be used for a variety of purposes, but they differ in important ways. From average annual percentage rates (APRs) to benefits and best uses, here’s a look at what you need to know about each to determine which is right for you.
Comparing personal loans and credit cards
A personal loan is most often an installment loan, while a credit card is a revolving form of credit. The main differences are in how the funds are disbursed to you and repaid. An installment loan gives you a lump sum upfront that is then repaid on a set schedule, typically with fixed equal payments over a period of years.
A credit card, on the other hand, gives you access to a line of credit to spend from, as needed, up to a certain limit. Unlike a personal loan, you can choose how much to repay each month, as long as you make the minimum required payment. As a result, credit cards have no pre-set payoff date, unlike personal loans.
Note
Credit card payments vary based on how much you put on the card and the balance you carry from month to month — if your balance is higher, your minimum payment is likely to be higher.
Another major difference between personal loans and credit cards is how they assess interest. Most personal loans charge interest at a fixed rate. This means that the interest rate you agree to when you sign the loan agreement will not change during the term.
But almost all credit cards charge variable interest, compounded on a daily basis. This means that the card’s APR, and therefore the amount of interest you’re charged, will change based on the prime rate. And interest may be added to your balance daily, on which additional interest will be charged.
Credit cards: Good to know
Though credit cards can be a big convenience, they do have certain pitfalls and advantages that personal loans do not.
- Compounding interest (pitfall): Any interest that goes unpaid from month to month on a credit card will also accrue interest charges. This is the same concept that can work to build up your retirement fund, working against you. This is a particular danger if you only make the minimum payment each month.
- Grace period (advantage): Most credit cards give you a grace period between the end of a billing cycle and the date your payment is due, during which time you won’t be charged interest. If you pay off your entire balance by the due date, you’ve just borrowed money at a 0% APR. Most other short-term borrowing options, like payday loans and cash advance apps, can have triple-digit APRs for two-week loans.
Impact on credit
Personal loans and credit cards can impact your credit score in different ways. In the widely used FICO credit scoring model, the amount you owe, including your credit utilization, contributes up to 30% to your score.
Taking out a personal loan will increase the amount you owe, but it will not increase your credit utilization (the amount of revolving credit you’re using relative to what’s available to you), whereas adding to your credit card balance will increase both. The result is a potentially larger negative net impact on your score.
Additionally, credit mix makes up 10% of your score, so if you already have a credit card and then take out a personal loan, it could diversify your credit mix and help boost your score, as will consistent on-time payments.
Personal loans vs. credit cards
How to choose between personal loans and credit cards
If you’re still wondering whether a personal loan or a credit card is right for you, here are some of the biggest things to consider before you sign on the dotted line:
Interest rates and fees
Interest rates and fees determine how much borrowing is going to cost you. On average, interest rates for personal loans are lower than on credit cards, but interest rates and fee structures will vary widely depending on your financial situation and the specific lender you’re working with.
And while personal loan interest rates are lower on average, some credit cards offer a 0% APR to new cardholders during a promotional period that begins once they’re approved for the card. After this, the card’s standard rate will kick in.
For instance, if you’re looking to buy a new refrigerator for $2,000 and are trying to decide between a personal loan and a credit card, you may be able to find a credit card with 0% APR offer that lasts several months.
Tip
If you can repay the amount you borrow by the end of your credit card’s grace period for that billing cycle (often between 21 and 25 days), you could avoid paying interest altogether.
Repayment terms
The flexibility of a credit card can be a downside or an upside, depending on how you’re looking at it. Being able to use it whenever you need it might be great, but having your payments and interest change from month to month might be a challenge for some.
Take a careful look at repayment terms of both personal loans and credit cards and make sure you’ll be able to make the monthly payment — with room to spare, ideally — before you take out the loan or spend the money.
Related: Personal Loan Term Length: What You Need To Know
Benefits
Personal loans rarely offer the same benefits that credit cards do — the benefits of personal loans are generally their competitive rates and stable repayment terms. Credit cards, on the other hand, can offer a variety of benefits, from travel points to cash back.
If you can use a credit card’s benefits wisely, they can really pay off, saving you money on everyday purchases, vacations, travel, gas, etc.. If you’re able to pay off your credit card bill in full every month, you could avoid interest charges and collect rewards.
Uses
What you plan to use the credit card or loan for can impact which you choose. If you’re making a one-time major purchase, a credit card that offers 0% APR might be a great choice if you can pay it off in that time frame — if not, a personal loan is likely better. If you’re consolidating debt, do your research based on what you expect to use the money for.
Keep in mind
When comparing your options, consider APRs. An APR accounts for both the interest rate and any upfront fees, and is a better indication of the cost of borrowing. In general, the lower a loan or credit card’s APR, the less you’ll pay overall.
Check Out: How To Compare Personal Loans
Pros and cons of personal loans
Pros
- Set repayment terms
- Fixed monthly payments
- A fixed interest rate
- Lower APRs on average
- Does not increase credit utilization
Cons
- Inflexible payments (if you need to pay less one month, you can’t)
- No (or limited) rewards
- Can’t borrow more than the initial loan amount
Pros and cons of credit cards
Pros
- Flexible payment structure
- Use as needed, up to your credit limit
- Possibility of rewards
- May have a 0% APR promotional period
- Grace period
Cons
- Compounding interest
- Variable interest rates
Check Out: Best Credit Cards
Personal loan or credit card for debt consolidation?
Debt consolidation is a common use for personal loans and credit cards. Here’s how it works. Let’s say you carry debt on a high-interest credit card. If you can move that debt to a personal loan or a balance transfer credit card with a lower APR, you may be able to pay it off in a shorter time frame, while also saving money.
Which one you select will depend on how quickly you can repay the amount, as well as whether you can qualify for a 0% APR credit card. If you choose a balance transfer, make sure you can repay the debt (or at least the bulk of it) before the standard rate kicks in.
Important
Factor the balance transfer fee if you’re considering using a balance transfer card to consolidate debt. It’s typically between 3% and 5% of the amount you transfer and will be added to your balance.
Personal loans are also a great choice for debt consolidation, especially since they offer longer repayment terms (up to seven years with many lenders).
Instead of a balance transfer fee, you may be charged an origination fee, which is deducted from the borrowed amount. Not all lenders charge origination fees, but you’re more likely to pay one if you have fair or bad credit.
Again, it’s important to do the math to ensure that you’re actually saving money by consolidating your debt via personal loan. A personal loan calculator can help with this, but also compare the loan’s APR to the rate you’re currently paying.
Check Out: Personal Loan Calculator
Expert editor insight: “Consolidating debt with a personal loan may be worth it even if you can’t get a lower APR — you can exchange multiple monthly payments for one, lower your monthly payments, and improve your credit score. This is most likely to be beneficial if you're currently struggling to make payments, but your credit score hasn't taken a big hit yet.”
— Meredith Mangan, Senior Personal Loans Editor, Credible
Learn More: How To Consolidate Bills
FAQ
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