Personal loan vs credit card: Which is best?

Are you planning a wedding, taking that long-awaited vacation, or upgrading your car? If you need to borrow money to cover these expenses, you might be weighing up whether to take out a personal loan or use your credit card. But which option is better?

Both personal loans and credit cards are widely used, but they work in different ways. A personal loan gives you a one-off sum of money that you repay over a set period, usually with fixed or variable interest. A credit card, on the other hand, provides a revolving line of credit that you can draw from and repay as required, on an indefinite basis.

So, which one is right for you—a personal loan or a credit card? The answer will come down to your particular needs, as well as how responsibly you will be able to manage a loan product and your spending habits.

How does a personal loan work?

A personal loan is a set amount of money that you will borrow from a bank or lender, often for a particular purpose such as a car purchase or a home renovation, that is to be paid back over a set period of time, with interest. You can generally choose between secured and unsecured personal loans.

Common characteristics of a personal loan include:

• Set borrowing over a fixed term: In most cases, a personal loan lets you borrow a set amount of money to be repaid over a fixed term – usually from 12 months to five or seven years.

• Fixed or variable interest rate: The interest rate on a personal loan can be fixed or variable. One of the benefits of a fixed rate is that the repayments will stay the same throughout the loan term, which can make repayments easier to budget for. With a variable loan, the interest rate (and your repayments) can increase or decrease during the term.

• Wide range of loan purposes: While the purchase of a vehicle is generally the most common loan purpose, many lenders offer personal loans for a wide range of reasons, be it paying for travel, home improvements, further education or for medical costs.

• Ability to tailor your repayments: Some lenders allow extra repayments, which can help to pay off the balance of your loan sooner, thereby lowering the overall interest cost. Some loans allow you to make unlimited repayments, while others cap the amount. Be aware that some providers charge early repayment fees.

How does a credit card work?

Credit cards offer you ongoing access to funds up to a certain limit. This means you can draw down funds up to a set amount of money, repay the funds, then draw on the available funds again at a later date. In this way, the credit offered by a credit card can revolve indefinitely, and you don’t need to reapply for more funds as you would with a personal loan.

However, it’s important to repay the amount you use in a timely manner to maintain available credit and avoid interest charges and penalties, which can be quite high.

Some common characteristics of credit cards include:

• Set credit limit: A credit card will come with a limit, which is the amount of money up to which you can draw on it—limits differ between cards and can generally be raised or lowered in consultation with your credit card provider.

• Interest-free days: Most credit cards come with an interest-free period, usually 44 or 55 days, before interest charges are added to your card balance. Interest-free days only apply if you pay off the card balance in full each month.

• Flexible card repayments: If you carry a card balance at the end of the statement period, the card issuer will only require you to make the minimum repayment. This can be set at as little as 2% of the outstanding debt.

• Opportunities to earn reward points:  Credit cards can be linked to reward programs where cardholders earn points based on their level of card spending. These rewards can then be redeemed for anything from airline flights to different types of merchandise.

• Perks like complimentary insurance: Some credit cards offer complimentary insurance, including complimentary travel insurance and purchase protection insurance. Here too, though, it pays to consider if these types of extras can mean paying more in card fees or interest rates.

Which have higher interest rates—personal loans vs credit cards?

It’s always important to shop around for any financial product as costs vary widely between providers. As a general rule though, personal loans tend to have lower interest rates than credit cards. It’s important to keep in mind, however, that the interest you pay on a credit card will depend on how you manage it.

Interest on a credit card is only payable on the outstanding balance each statement period. If you continually pay off your balance on time, it is possible to avoid paying any interest charges. By contrast, interest on a personal loan applies to the amount outstanding, which is paid off over time.

Which have higher fees—personal loans vs credit cards?

Personal loans can come with a variety of fees including a one-off loan application fee, and potentially a monthly account-keeping fee. There can also be early repayment fees, depending on the loan. Many of these fees are included in the loan comparison rate. This makes it a good idea to use the comparison rate to make an apples-for-apples comparison between different personal loans.

Credit cards can come with fees too. Some, though not all, credit cards charge annual fees. Both personal loans and credit cards can charge late payment fees if a regular repayment is missed.  Fees may also apply if you exceed your card’s credit limit or fail to make your required repayment on time. Other possible fees include cash advance fees if you draw cash out of the card through an ATM, and foreign currency conversion fees, which may apply if you use your credit card while travelling overseas or to make international purchases online.

It’s also important to note that the more perks a credit card offers, the more expensive the fees are likely to be—a rewards credit card that offers frequent flyer miles and airport lounge access is likely to cost a good deal more in fees than a basic card that offers no rewards.

Credit cards vs personal loans—which is better?

Both personal loans and credit cards have the potential to be useful, but which one is better will depend on how you plan to use them.

If you need to borrow a one-off amount of money for a specific purchase, for example a car purchase, then a personal loan might suit your needs. On the other hand, if you want to earn rewards for everyday spending and are confident that you will  be able to avoid interest by paying off your balance each month, then a credit card might be suitable for your needs.

If you’re looking to manage day-to-day expenses and have good control over your budgeting and spending, a credit card could work well. But if you need to borrow a lump sum for a larger purchase or want more time to repay, a personal loan could be worth considering.

To help you decide which is better for your needs—a personal loan or credit card, we sum up the main pros and cons to consider.

What are some pros of personal loans?

• Lower interest rates: The interest rates attached to personal loans tend to be lower than credit cards, so if you foresee yourself paying back a larger sum of money over a longer period of time, this may be the preferable option.

• Potential to access more funds: If you intend on making a large purchase such as a vehicle, a personal loan may be appropriate as the amount you’ll need to borrow may exceed the limit of a credit card.

• Certainty in your repayments: When you take out a personal loan, you’ll know exactly how much you need to pay each month, and the end date, making repayments potentially easier to manage in your budget.

• Potential to still have access to your funds:  Some personal loans come with redraw facilities, which allow borrowers to draw on cash they’ve paid if they need it back. It’s important to be aware that not all personal loans offer this feature, though.

• Ability to consolidate debt: If you have debts owing from multiple sources and are paying multiple sets of interest charges across various loans, you can consolidate these into a personal loan to streamline your repayments and potentially help lower the amount you’re paying in interest.

What are some cons of personal loans?

• You’ll have to pay interest no matter what: Interest is charged on the outstanding balance of a personal loan until it is paid off in full. This means that you’ll have to pay interest each statement period, unlike with a credit card, which can allow you to avoid interest if your balance is paid in full each month.

• Personal loans lock you into a contract: A personal loan locks you into a contract to repay the money you’ve borrowed over a set period of time. If you need to restructure the loan at any point, break fees can apply, which can be expensive. You may even face a penalty if you decide to repay the balance of the loan before the end of the term.

• No further access to credit after repayment: As personal loans are one-off amounts of money, you will not have ongoing access to funds if you need to borrow again in future, and you’ll need to reapply for more, which is not the case with a credit card.

• You can lose your asset: A secured personal loan uses an asset as security (in the case of a car loan, the vehicle itself). If you are unable to make your required repayments, your lender will have the right to repossess it to recoup their costs.

What are some pros of credit cards?

• The flexibility to access funds when you need money: A credit card is essentially an indefinite, revolving line of credit, and if you have one, you can access funds up to your limit when needed, without needing to apply for a loan.

• Interest is only paid on the funds drawn down: Interest is only payable on funds you’ve drawn on a credit card, so if you do not carry a balance from month to month and pay your card off in full, you can potentially avoid paying interest.

• Reward programs and extras: If you use a credit card responsibly and pay off your balance with each statement to avoid interest, then perks like reward points or airline miles can be a welcome bonus. Keep in mind, though, that rewards cards still do tend to come with higher fees than more basic types of credit cards.

• Useful for everyday spending: Credit cards can be drawn down at any time, and as they are also a lot more secure than carrying cash, credit cards can be useful if you are travelling. Credit cards can also be handy for people who have irregular income patterns or as back-up for emergency bills or unexpected spending.

What are some cons of credit cards?

• Fees and charges: It’s important to keep in mind that even if you pay off the balance of your credit card in full each statement period and avoid interest, fees and charges may still apply. And, depending on the kind of card you have, these can be substantial.

• Debt can build quickly: Sticking to the minimum repayments on your credit card may be easier on your budget compared to paying off the full balance, but it will increase the interest cost for the month, which is then added to the outstanding debt. In this way, it can take longer to clear the card balance and costs can grow significantly over time.

• Temptation to overspend: Access to a generous credit limit can make it tempting to overspend, if you adopt the mindset that the money is available to you so you might as well treat yourself, and you can worry about repaying it later. Used irresponsibly, credit cards can put you in a significant amount of debt if you are unable to pay the balance owing and interest charges pile up.

No matter whether you choose a personal loan or credit card, or both, it’s important to shop around and compare different products looking at rates, fees and features to be confident you have the product best-suited to your needs. It’s also important to only borrow what you can afford to repay and indeed to consider carefully if taking on debt is appropriate for your situation.

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