Personal Loan vs. Credit Card: Which Is Best for You?

Credit cards are great for everyday purchases, like buying groceries before your paycheck clears, and even unexpected expenses that you can pay off quickly. But if you need to carry a balance, the interest charges can add up fast. Personal loans are generally a better fit when you need to pay for a large purchase over time. 

There are caveats, though. If you need to borrow money, you should understand the differences between personal loans and credit cards, how these two financial tools impact your credit, and when to choose one over the other or something else entirely.

Brief overview of each funding option

How personal loans work

When you apply for a personal loan, the lender checks your credit report and verifies your income. If you’re approved, you get a lump sum of cash in your bank account (or delivered to creditors if you’re consolidating other debt). You can use the money for almost any personal expense, but you typically need to specify how you intend to use the funds when you apply. You repay the full loan amount plus interest in equal monthly installments, typically over several years. Most personal loans have fixed interest rates, so the monthly payments are predictable. 

The average interest rate on a two-year personal loan is 11.57%, according to the Federal Reserve. However, rates range from 6.49% to 35.99, depending on your credit score, the loan’s purpose, and the repayment term you choose. Repayment terms generally range from two to seven years, though some lenders offer longer terms for home improvement loans. 

How credit cards work

A credit card is a type of revolving credit that allows you to make purchases up to a credit limit. There’s virtually no limit on what you can buy with a credit card — as long as the seller accepts credit cards and your card carrier as a form of payment.

Most credit cards feature a grace period, so you don’t owe interest on your purchases until the due date. You also don’t have to pay off the full balance by the due date. However, you must make at least the minimum payment every month to avoid a late fee, and interest begins accruing on any remaining balance once it carries over to the next billing cycle. 

If you pay your balance in full every month, you won’t pay any interest. Many credit cards feature:

• interest-free promotional periods that can last up to 21 or 24 months 
• sign-up bonuses for spending a certain amount within the first few months
• cash back or other rewards

The average credit card interest rate is 21.16%, according to the Federal Reserve. However, standard annual percentage rates (APRs) can range up to and over 30%. Borrowers with good credit could be eligible for low-rate credit cards with standard APRs starting around 15%. 

Similarities and differences

Similarities of personal loans and credit cards

• Flexible repayment options: Both personal loans and credit cards offer some repayment flexibility. Most personal loan lenders give you a choice of repayment terms upfront and give you the option to make extra payments or repay the loan early at any time. Credit cards allow flexibility from one month to the next — you can choose to pay any amount between the minimum payment and the statement balance. 
• Incidental fees: Personal loan lenders and credit card issuers tend to charge similar incidental fees, like late payment fees and returned check fees. 
• Monthly payments: Most personal loan and credit card agreements require you to make a payment at the same time every month. Some lenders allow you to change your due date, but may limit how often you can do so. 

Differences between personal loans and credit cards

• Interest rates: While personal loans typically have fixed APRs, most credit cards have variable APRs, which change as current rates change. According to the Fed, personal loans have lower APRs by almost 10 percentage points, on average, than credit cards. 
• Credit type: Personal loans are a type of installment credit with fixed monthly payments over a predetermined term, while credit cards are a type of revolving credit — you can borrow (make purchases) repeatedly, and as you make payments, your credit line replenishes. 
• Impact on credit score: While both personal loans and credit cards impact your credit score, only revolving lines of credit (like credit cards) affect your credit utilization. Credit utilization is part of the “amounts owed” category, which contributes 30% to your credit score. 

Impact on credit

How personal loans affect your credit score

When you formally apply for a personal loan, the lender runs a hard credit inquiry, which typically causes a small dip in your credit score. If you’re approved for and accept the loan, it will increase the total amount of all debt you owe (if you’re not using it to pay off other debt). 

That increased debt balance can negatively affect your credit until you pay it down. A series of on-time payments may give your score a boost, while missed payments may damage your credit. If you use a personal loan for debt consolidation, your credit utilization ratio will improve, which can positively impact your score. 

How credit cards affect your credit score

Like personal loan lenders, credit card issuers perform a hard credit check when considering your application for a new credit card. Beyond the initial dip in your credit score, the impact of the card on your credit score depends on your payment behavior. 

By opening a credit card, you gain access to a credit line. The amount you use of that credit line directly impacts your credit score — a low credit utilization can help your score, while a high one can hurt it. It’s a good practice to keep your credit utilization below 30% to avoid a credit score hit. For instance, if you have a $10,000 credit limit, you’d want to keep your balance below $3,000. But the best practice is to pay off credit cards every month. 

Like personal loans, on-time credit card payments will help your score (even if you carry a balance), while late payments will hurt it.

Pros and cons of personal loans

Pros and cons of credit cards

Alternative funding options

Buy Now, Pay Later (BNPL)

BNPL is a method of payment you can choose at many online retailers. A third-party BNPL provider like Klarna or Affirm pays the retailer, and you agree to repay the BNPL provider. You can typically choose between two options — four bi-weekly payments with no interest or a longer-term installment plan that may charge interest up to 36%. BNPL is convenient and cheap when you know you can pay off the purchase fast, but it can be costly if you extend repayment and don’t qualify for low-interest financing. 

Personal line of credit (PLOC)

If you’re looking to fund a project with ongoing expenses and you know you’ll need to carry a balance, a personal line of credit may offer the flexibility of a credit card at a lower APR. You can draw cash against your credit limit on an ongoing basis and repay what you use. Some banks and credit unions offer PLOCs to their account holders, but they can be difficult to qualify for and may have higher APRs than personal loans. 

Home equity loan or HELOC

If you have equity in your home, you can borrow against it with a home equity loan or home equity line of credit (HELOC). Both financing options are secured by your home, so there’s a risk of foreclosure if you fail to repay. But they typically come with lower interest rates and longer repayment terms than unsecured loans. 

Home equity loans offer a lump sum like a personal loan, while HELOCs allow you to borrow repeatedly like a credit card. Both require an appraisal and closing costs, so they’re best for homeowners with large expenses and plenty of time.