Personal Loans vs. Credit Cards: What’s the Difference?

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Personal Loans vs. Credit Cards: What’s the Difference?

Personal Loans vs. Credit Cards: An Overview

Personal loans and credit cards both provide a means to borrow money and share many of the same conventional credit terms. Loan and credit card agreements often include money supplied by a lender at a predetermined interest rate, monthly payments that include principle and interest, late penalties, underwriting criteria, quantity limitations, and other terms. Mishandling any sort of credit may harm your credit report, making it difficult to get loans, locate appropriate housing, and find work.

However, in addition to the similarities between personal loans and credit cards, there are significant variations, such as payback conditions. Let’s look at the definitions and distinctions between the two, as well as the benefits and drawbacks of each.

Key Takeaways

  • Personal loans provide borrowed cash in one lump payment with comparatively lower interest rates; they must be repaid over a certain time period.
  • Credit cards are a sort of revolving credit that allows borrowers to access monies as long as their account is in good standing.
  • Credit scores play an important role in determining loan approvals and conditions for both personal loans and credit cards.
  • Personal loan and credit card agreements may include a broad range of clauses and phrases.
Personal Loans vs. Credit Cards

Investopedia / Lara Antal

Understanding Credit Scores

Before delving into the distinctions between personal loans and credit cards, it’s critical to grasp one of the most significant commonalities. The United States and the majority of other nations have implemented a credit score system that serves as the foundation for credit approvals. The three largest credit bureaus in the United States—Equifax, Transunion, and Experian—are pioneers in developing credit scoring standards and collaborating with lending institutions to facilitate loan approvals. 1

Credit scores are determined by a person’s credit history, which includes credit defaults, queries, accounts, and outstanding amounts. Based on this history, each person is awarded a credit score, which substantially determines their prospects of credit acceptance. All of the criteria assessed by a lender may affect the interest rate a borrower pays as well as the amount of principle for which they are authorized. 1

Personal loans and credit cards may both be unsecured or secured, which affects the credit conditions.

Paying off your credit card bill and repaying personal loans on schedule may both help you improve your credit score.

Personal Loans

Within the personal loan category, lenders provide a number of alternatives that might impact credit terms. The key distinction between a personal loan and a credit card is the long-term debt. Personal loans, unlike credit cards, do not provide continual access to cash. A borrower receives a lump sum up front and has a certain amount of time to return it in full through monthly installments and retire the loan. For borrowers with good to excellent credit, this agreement normally includes a cheaper interest rate. 2

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A personal loan may be utilized for a variety of purposes. An unsecured loan may give capital to finance significant expenditures, restructure credit card debt, repair or renovate a property, or bridge a gap in income receipt. Unsecured loans have no collateral pledged by the borrower.

Personal loans include home loans, vehicle loans, and other sorts of secured loans. These loans will follow conventional credit approval processes, but they may be simpler to get since they are secured by a lien on assets.

In the case of a house loan or an auto loan, for example, the lender has the authority to seize your property or automobile after a certain number of delinquencies. Secured loans often have somewhat better terms since the lender has ownership rights involved, lowering the lender’s default risk. Here are some of the benefits and drawbacks of a personal loan.

Pros

  • Generally best for large purchases like homes or cars

  • Usually offers a lower interest rate than a credit card

  • Provides funds in one lump sum

Cons

  • Usually contains a service charge and additional expenses that pile up.

  • If you do not repay on time, anything used as collateral, such as a vehicle or house, may be taken (secured loans)

Keep in mind that interest is not the only cost to consider when taking out a loan. Lenders often impose fees, which may add to the overall cost of a loan. Personal loans generally involve an origination charge as well as extra expenses.

Line of Credit vs. Loan

The contrast between a line of credit (LOC) and a loan is worth mentioning. A line of credit, unlike a loan, has built-in flexibility, which is its primary benefit. One downside is that it usually entails higher interest rates.

A LOC is a predetermined loan amount that borrowers are not required to spend in its whole. A borrower may withdraw cash from their line of credit at any time as long as they do not exceed the credit limit restrictions and meet other obligations, such as paying minimum payments on schedule.

A LOC may be secured or unsecured (the majority being the latter) and is often provided by banks. A home equity line of credit (HELOC), which is backed by the borrower’s home equity, is a notable exception. 3

Credit Cards

Credit cards are classified as revolving credit, which is a kind of borrowing. A revolving credit account normally provides the borrower with continued access to cash as long as the account is in good standing. Credit limits on revolving credit card accounts may also be increased on a monthly basis. Personal loans often have higher interest rates.

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Revolving credit is not the same as a personal loan. Borrowers have access to a certain amount, but they do not obtain it in full. Rather, the borrower may withdraw monies from the account at any moment up to the maximum amount. Borrowers only pay interest on money used, therefore a borrower may maintain an open account with no interest if there is no balance.

Credit cards come in a variety of shapes and sizes, and they provide a lot of convenience. 4 The finest credit cards may provide 0% introductory interest rates, debt transfer options, and perks. Some, on the other hand, may have high annual percentage interest rates mixed with monthly or yearly fees. Generally, all credit cards may be used everywhere electronic payments are accepted.

High-quality cards with rewards points may be quite useful for borrowers who take advantage of the benefits and pay off their amounts on a regular basis. Cash back, points for discounts on purchases, points for store brand purchases, and points for vacation are all options for rewards cards.

Credit cards may be unsecured or secured in general. Unsecured credit cards provide credit with no collateral. Secured cards are sometimes an alternative for individuals with poor credit. A secured card requires the borrower to contribute money toward the card’s balance limit. Secured cards have different conditions, so some may equal the secured balance, others may give an increase after a certain period of time, and yet others may apply the secured balance to the card as a payment after many months.

Overall, each credit card will have its unique method of accruing interest, therefore it is critical to read the tiny print. Unlike personal loans, where your monthly payment is generally the same throughout the payback term, your credit card charge will change from month to month.

Some credit cards provide borrowers with the benefit of a statement cycle grace period, which enables them to freely borrow cash. Other cards will impose daily interest, in addition to the monthly interest fee. Borrowers using credit cards that have a grace period may discover that they have around 30 days to buy anything interest-free if the amount is paid before interest starts to rise. 5

Pros

  • Continuous revolving credit balance that charges interest only when funds are utilized

  • Cards featuring 0% introductory interest rates, grace periods, and prizes are available to consumers with solid credit.

  • Accounts in good standing are normally eligible for regular credit limit increases.

  • For people with little or bad credit, the chance to gradually improve credit conditions.

Cons

  • Interest typically higher than personal loans

  • Interest and fees can add up

  Alternatives to a Home Equity Line of Credit (HELOC)

Overall, financing using a credit card may seem to be a straightforward choice on the surface, but as with any borrowing, it is important to do your homework. Credit cards, which may be offered with 0% interest and grace periods, might be a feasible alternative to personal loans. Other benefits include convenience and reward points. However, like with any credit borrowing, interest and fees may be a significant burden.

If you’ve been saddled with an expensive card and are searching for something with a lower interest rate, there are numerous cards available right now that are great for anybody wishing to transfer their balance.

Other Types of Credit Lending

Loans and revolving credit cards account for a significant portion of the entire credit market. However, in addition to typical personal loans and credit cards, there may be alternative credit products to consider. Here are a few such examples:

Business Loans and Credit Cards

All sorts of firms may benefit from business loans and business credit cards. Underwriting a business loan often entails an examination of financial accounts and expectations. Business credit cards may be obtained more easily and give the same benefits as personal revolving credit cards.

Payday Loans

Payday loans are available at exorbitant interest rates. Borrowers acquire cash advances by using work pay stubs. Payday loans are called predatory loans because of their exorbitant interest rates and costs. 6

Special Considerations

In general, credit may be a dangerous enterprise that needs the borrower to exercise caution. Because the structure of credit agreements may allow for predatory lending and lending fraud, it is critical to understand credit conditions and confirm that you are borrowing from a legally permitted company in order to protect yourself financially. 7

The Bottom Line

Not all credit is created equal. Personal loans and credit cards may have a broad range of features and terms. Personal loans offer lower interest rates than credit cards, but they must be returned over time. Credit cards provide you continuous access to cash, and you only pay interest on outstanding amounts that aren’t paid off on time.

Whether you pick one or both, your credit score is critical to obtaining approval and advantageous conditions. In the case of the former, a personal loan calculator will assist you in better understanding how your credit score will effect your monthly payments.

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