Personal Loan vs. Credit Card: Which Should You Use?
Personal loans and credit cards are both useful financial tools that offer convenient access to funds, but they work in slightly different ways. So how do you know which one is best to use in different situations?
Generally speaking, a personal loan is great if you have a particular project or item in mind, whereas a credit card can be used to meet ongoing expenses – yet the line between them isn't clear-cut. Read on to find out more about personal loans vs. credit cards.
How a Personal Loan Works
When you take out a personal loan, you borrow a fixed amount of money and pay it back in equal installments until it's all paid off.
Here's what you need to know about personal loans:
- The amount you borrow is called the loan principal. You may be asked how you plan to use the funds, but you don't need to account for every dollar.
- You agree to pay the funds back over a length of time called the term. For example, you may choose between 12 and 60 months.
- You'll get an annual percentage rate (APR) and the interest will be included in your monthly payment.
- Usually, a shorter term means a lower APR, while a longer term may mean a lower monthly payment but a higher APR.
- Depending on your lender, you might need to pay origination fees (to take out the loan) or prepayment penalties (if you pay it off early) – so try to avoid these. OUCU Financial does not have these fees.
- Making timely monthly payments is a good way to establish credit or boost your credit score!
How a Credit Card Works
When you get a credit card, you'll get a limit on the funds you have available and your monthly payment will depend on how much of that credit you used.
Here's what you need to know about credit cards:
The maximum amount of funds you can use is called your credit limit.
You can use your credit card to pay for anything, as long as the vendor accepts credit cards. For example, some shops may have a minimum purchase amount or may add on a fee if you want to pay by credit.
Each month, you'll get a bill with a minimum payment due and you need to pay at least that amount – on time – to avoid a late payment fee.
You'll get an annual percentage rate (APR) based on your credit score and pay interest on the balance of your card each month. If you have a zero balance, you'll pay zero interest!
Credit cards may come with an annual fee or higher rates for balance transfers and cash advances – so be sure you read the fine print to find a good offer. OUCU has no annual, balance transfer or cash advance fees.
To boost your credit score, it's a good idea to pay more than the minimum due so you keep a healthy debt-to-credit ratio and never use all of your available credit.
When to Use a Personal Loan
You can use your personal loan to pay for a single item or project that you've been planning, or you can allocate a part of the funds to cover different expenses.
Here are a few common scenarios when people might choose a personal loan:
You know how much money you need to borrow and you want to pay it back in equal monthly installments to make budgeting easy.
You have a big project or item in mind, such as remodeling your house or buying a new dishwasher.
You have a special event coming up. For example, a family vacation or wedding.
You have a stack of expenses you need to pay, like car repairs, health care, vision, or dental bills.
You have a few different credit cards and you want to consolidate that debt into one simple loan.
When to Use a Credit Card
Nowadays, credit cards are becoming a preferred method of payment due to their enhanced protection from fraud and because you may get the chance to earn rewards on purchases.
Here are the moments when people might choose to use a credit card:
You want a secure way to shop online and the option to use your mobile wallet.
You want limited liability (maximum of $50!) if your card is stolen and used for fraudulent purchases or purposes.
You want to collect points on your regular expenses like groceries and gas – and redeem your points for cash, travel, merchandise, and more.
You've run out of cash and need to put a few purchases on your credit card until you get your next paycheck.
You don't plan to use your credit card regularly but want to keep it in your drawer as a financial safety net – and pay no interest when you don't use it.
The Bottom Line on Personal Loans vs. Credit Cards
There isn't a clear winner between personal loans and credit cards because it comes down to your unique financial circumstance and needs. If you want the flexibility to access different amounts of funds at different times, a credit card could be ideal.
But if you're the kind of person who knows exactly what you want to achieve – and likes to know exactly how much you owe at all times – a personal loan might have your name all over it.
Click below to find out more about personal loans!
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