Myth or fact: Credit cards and personal loans are practically the same.
"Personal loans and opening a new credit card are, at the core, the same concept," begins Brett Holzhauer, credit card writer at FinanceBuzz.com, "you are borrowing money with the promise of paying it back. However, the purpose and application of both of these products are vastly different."
In this article, we are going to explore the similarities and differences between these two financial products, as well as answer the big question: Should I get a credit card or a personal loan?
Aren't credit cards and personal loans basically the same thing?
"Opening a credit card or a personal loan are both ways to afford a purchase that you'd otherwise not be able to afford," says Dane Janas, an IRS-licensed Enrolled Agent and host of the Financially Boundless Podcast and YouTube channel, CEO of Boundless Tax. "Both have their advantages and both have their drawbacks."
So, which is best?
On our quest to understand which option is best for which consumer, Ronda Brunson, Certified Credit Counselor and Certified Financial Educator, known as Ms Brunson Credit Queen, starts us out: "First, we have to recognize that these are two totally different account types." So, let's explore these two types of credit, on a basic level.
What is a credit card?
"A credit card allows you to borrow money up to an approved credit limit," explains Abigail Welles, Content Specialist at Credit Card Insider. "A credit card is considered 'revolving' debt, meaning you can continue to borrow money as long as you have not hit this limit. If you do not pay off your balance, you’ll get hit with interest, which can effectively keep [consumers] in debt."
"[M]onthly repayment requirements vary depending upon the balance," explains Brunson.
What is a personal loan?
"A personal loan is 'fixed' debt," says Welles, "which means that you’ll receive a fixed amount of money along with a payment plan of consistent installments to pay this borrowed amount back."
Brunson adds, "A personal loan is an installment account which means it has a maturity date and regardless of the amount spent, the monthly payment and terms remain the same."
"Credit cards are meant for those with the financial means of paying their monthly statements," says Holzhauer, "while personal loans offer access to cash that you will pay off over a predetermined time in the form of debt."
Both of these options will provide you with spending money, but there are pros and cons to each. Let's take a look at the general pros and cons for both types of credit, starting with credit cards.
Credit card pros and cons
Easy to access
"Credit cards are the 'uglier' version of a loan," says Janas, "and are also offered by virtually every financial institution — big and small. They usually have higher interest rates than personal loans, but the approval process is quicker and less strict with some cards, so you stand a chance of being approved even if your credit history wasn't always wonderful."
Jared Weitz CEO and Founder of United Capital Source Inc. adds, "There is a sense of easy access to apply and receive a credit card, so if you need money quickly, this is a strong option to consider when compared to the sometimes lengthy process of applying for and receiving a personal loan.”
The fact that credit cards are revolving debt means that your payments are based on your use and you are not necessarily stuck with a long-term contract.
Additionally, revolving debt lets you functionally use more money on the same account. Once you pay it off, you have access to it again.
Opening a new credit card can help improve your credit score. On-time payments will help increase your score and new credit availability helps improve your credit utilization percentage.
Credit card rewards
"Credit cards come with the ability to earn rewards in the form of cash back or travel rewards," says Holzhauer, "while personal loans do not have any sort of rewards."
These rewards are especially beneficial for consumers who use them wisely, while still paying off balances monthly.
"Lots of credit cards offer you a no-interest period, ranging from a few months up to two years," advises Thiago Glieger, Private Wealth Manager with Risk Management Group. "If you know you'll be able to pay off the amount that you're going to charge on the credit card off before the no-interest rate period expires, by all means, use that benefit. Just be sure to set up automatic payments so you don't forget to pay."
High interest rates
"Some credit cards are charging up to 28 percent or more for revolving credit," emphasizes Tony Matheson, CFP®, a wealth advisor and founder of Matheson Financial Partners LLC. "You can often find personal loans or installment loans for similar terms with an interest rate in the teens."
In addition to the high interest charged by credit card companies, these cards often come with variable rates that change over time. This means there is potential for a rate increase
We put this one in both the pros and cons column because revolving debt can often be a stress on people with unresolved spending habits. It can be a temptation to spend more because you always have access to more. Revolving debt can feel less like incurring a debt and more like available funds.
Just as a credit card can have a positive effect on your credit score, if your payment habits are not so good, or you are unable to make on-time payments, it can really hurt your credit score, as payment history accounts for the biggest chunk of your score.
Credit card fees
Credit cards come with their own set of fees. Here are three examples:
Annual fees — Some cards carry annual fees that are charged once a year.
Late fees — If your payments are late, you will likely be assessed a late fee, determined by your financial institution.
Cash advance fees — if you need access to quick cash, you can get a cash advance, but it can come with a fee
Personal loan pros and cons
High loan amounts available
"If you need a loan for a large amount, then it is better to take out a personal loan than open a new credit card account," says Logan Allec, a CPA and owner of personal finance site Money Done Right. "For example, if you need to spend $40,000 to remodel your home, then a personal loan works best for you. This is because personal loans are commonly available for those with good credit to make large purchases. It is highly unlikely that you would open a new credit card account, and the limit would be anywhere near $40,000. This makes a personal loan the better option for taking out a loan to receive a large sum of money."
Lower interest rates
"[Personal loans] generally maintain a lower interest rate than most credit cards," says Janas, "but each financial institution is going to have its own stipulations on your loan or line of credit."
While a credit card generally offers a variable rate, most personal loans have a fixed interest rate. This is nice because you can see, from the start, what amount of interest is going to be paid with each of your installments.
Not revolving credit
This means that you will have higher, fixed monthly payments than you would with a credit card, where you only have to make a minimum payment.
Personal loans are pre-set.
Effect on credit
If you open a personal loan and make on-time payments, then you can definitely have a positive impact on your credit history. Additionally, if this is your first installment-type of credit, it will boost your credit mix.
If you use a personal loan to consolidate credit card debt, your score will get a boost because you are freeing up available credit.
Harder to get
"Personal loans tend to be 'friendlier' and are usually offered both by small, local and large, national banks" comments Janas.
He adds, "Generally, the underwriting is more advanced as well, so you stand a lesser chance of actually being approved if you have less-than-stellar credit."
Personal loan fees
Personal loans also have their own set of fees that come along with them.
First, an origination fee is normally built into this type of loan. It is a percent on top of your interest rate that is either charged upfront or worked into the payment schedule
Just like any other type of loan or a credit card, when you make a late payment, you may be charged some sort of fee
A prepayment penalty is often applied to installment based loans when you want to pay off the loan before the whole term is out. Check with your lender just so you know the cost and procedure if this possibility comes up.
Not revolving credit
"Unlike a credit card, a personal loan does not act as a revolving line of credit. You can only borrow a certain amount of money. This will help hold you back from spending even more and putting yourself even more into debt." says Weitz.
Effect on credit
Just like anything else, if you don't make on-time payments, your personal loan isn't going to help you build credit.
An aside about rates:
Average Credit Card APR
Average Personal Loan APR
Sometimes a credit card will work best and sometimes a loan will work best. Zach Hendrix, Co-founder of GreenPal which is best described as Uber for lawn care, provides the following example:
"We decided to use our Chase credit card instead of a personal loan to fund our business. Debt can magnify mistakes; however, when used wisely it can be a powerful fulcrum.
When we launched our business two years ago we had no money and no outside capital to get started with. Like most tech startups, we went on the fundraising circuit talking to angel investors and venture capitalists begging for money to get started. However, our vision was just too broad in scope and luckily we got turned down and told no over 40 times.
I was fortunate enough to have solid personal credit, and this enabled my team to secure an unsecured line of credit for $85,000 to get our business started. We dipped into the entire credit limit through three cash advances we got off of my personal credit card to get us through the first year.
We paid that off in the second year, and this year we're going to surpass $3 million in annual revenue.
Good thing early investors told us no because with their capital they would have owned and controlled 30 percent of our business and because we are self-funded, my cofounders and I own it all."
When a credit card will work best
You just need extra cash
"I recommend opening a new credit card when you just need extra cash flow for whatever reason. Maybe you need to make several smaller purchases over the next couple months, or maybe you're looking at purchasing at one specific retailer (who maybe offers their own co-branded credit card)."
— Dane Janas, IRS-licensed Enrolled Agent and host of the Financially Boundless Podcast and YouTube channel, CEO of Boundless Tax
You are a responsible borrower looking for rewards
"If you are in a decent financial situation and are looking to earn rewards for your everyday expenses with the ability to pay off your balances each month, a credit card would suit you best."
— Brett Holzhauer, Credit Card Writer at FinanceBuzz.com
"I only recommend credit cards for those who can pay off the balance each month. If you consistently can do this, then you probably qualify for one of the cards that include perks like cash back or points that can be converted to airline miles or hotel stays. If this is you, then research which one would benefit you the most and charge your daily expenses on the card and rack up those points!"
— Tony Matheson, CFP®, Wealth Advisor and Founder of Matheson Financial Partners LLC
You can pay the balance off before any interest accrues
"If you need an amount of money that you can pay off before any interest hits your new credit card account, then it would be a better idea for you to open a new credit card rather than take out a personal loan.
For example, you should open a new credit card rather than take out a personal loan if you need to pay $1,400 for a brand-new computer, and you are able to pay the cost of the computer back before any interest hits your credit account. This is a better option than taking out a personal loan because the personal loan would have a minimum fixed monthly payment that would continue to accumulate interest."
— Logan Allec, CPA and Owner of personal finance site Money Done Right
You want to make online purchases
"If the borrower is looking to have access to credit when they need it and to make online purchases, then a credit card has those advantages. Credit card balances should be paid off monthly; if the borrower finds that they are unable to do that then there could be larger financial issues."
You get a special offer and you have good self-control
"There are times when a credit card is a better option. If you are a consumer who is able to hold yourself back from spending a credit card beyond your means, opening a new credit card is a good option when the introductory rate is 0 percent."
— Jared Weitz CEO and Founder of United Capital Source Inc.
"One option would be to get one or more introductory zero-interest credit cards and initiate a balance transfer. Be sure to monitor the date when the interest rate springs up to the normal card rate and be prepared to either pay it off or do another transfer to card number two before the deadline. The low rate period is usually for up to 12 months maximum."
— Mark Charnet, Founder and CEO of American Prosperity Group
"Credit cards can also be an option for financing large purchases if you qualify for a 0 percent interest offer and can pay down your debt within the prescribed period."
— Abigail Welles, Content Specialist, Credit Card Insider
If it's for emergencies or occasional spending
"If the need is for emergencies or occasional spending then credit cards would be the route to take."
— Ronda Brunson, Certified Credit Counselor, Certified Financial Educator, Ms Brunson Credit Queen
When a personal loan will work best
You have good credit and are confident about making payments
"Personal loans are a good pick if you have good credit and are confident that you can successfully make monthly payments throughout the loan term."
You need to make large purchases, like for home improvement
"If you are using the money for cash purchase or a one-time major expense and will need to pay it over time, you are usually better off taking a personal loan."
"Yesterday, I spoke with a client who had opened an $11k credit card with Discover but by August he had spent $5200. Discover suspended his access to the account until he agrees to a 4506T form to verify his income. Clearly a person with great scores and disposable income should not be spending that much that fast.
...if you need cash upfront that you won't be penalized for then a personal loan would be best."
"I recommend personal loans to clients when you plan on making a certain number of large purchases (possibly even just one). For example, if a necessary home improvement rears its ugly head, and you don't have enough equity in your home just yet to have a HELOC, a personal loan or personal line of credit could be the ticket.
You are consolidating debt
"If you have a verifiable steady income and a decent credit score, then it is likely you can qualify for a personal loan that would be at a lower rate than a credit card. There are some personal loans available to consumers that have interest rates as low as 6-7%. This is a great way to pay off your credit debt, get a lower interest rate than what you are presently paying, and consolidate your debt. If you opened a credit card that you were going to use as to balance transfer your debt, you would not be able to take out as much money and you would more than likely have a higher interest rate than a personal loan."
"Because personal loans often have lower interest rates than credit cards and have longer repayment terms, personal loan are better for debt consolidation or refinancing. A personal loan used to consolidate debt can result in simpler money management, which can save you money on interest payments."
— Xavier Epps, founder and CEO of XNE Financial Advising
"Another option would be to take an unsecured personal loan, sometimes referred to as a signature loan, for the longest period of time at the lowest rate possible to pay-off the high interest debt, and most importantly, cut up the card so you never use it again.. Don’t cancel the account though, as this will negatively affect your credit score."
You need to pay an unexpected bill and you can qualify for better rates
If you are in a tight financial situation and need short term assistance with a predetermined date of paying it off, a personal loan would fit best rather than a credit card. Personal loan interest rates are typically much lower than credit card interest rates.
"If they are looking to pay unexpected bills then an installment loan can be best. In some situations, the interest rates will be lower and it will have positive aspects for the borrower's credit score."
If you need a long time to pay it off
"If you're going to need more than a couple of years to pay off the loan, a personal loan is probably better. Personal loan interest rates will be much, much lower than Credit Card interest rates. Sometimes you can get better rates by doing a Home Equity Line of Credit, but that collateralizes your house in the event you can't make the payments. It also takes longer to apply for it.
Still not sure?
If you are still not sure which option is best for you, here are a few things to think about:
"The easiest way to consider which option is best is to determine the use of the borrowing," advises Adam Marlowe, Principal Market Development Officer at Georgia's Own Credit Union. "As a consumer, are you looking to use the funds for a one-time purchase or do you want access more periodically? Keep in mind, personal loans generally have a fixed rate and a fixed term. Credit cards generally have a variable rate and have no term. Answering that question should determine which path you pursue."
Are you looking for ongoing access to revolving credit, or do you just need money for something specific, like home renovation?
Next, consider your credit score. Is it currently good, fair, or just plain bad? "Taking out a personal loan with a low credit score can put you in a more challenging position than if you just used a credit card," advises Chane Steiner, CEO of Crediful. "A low credit score means the personal loan could have a higher interest rate than a credit card. The loan has to be paid back within a predetermined time frame while you have infinite flexibility to pay off the credit card.
Another option to consider is credit unions. They offer loans at reasonable rates to people with low credit scores."
How is your credit score doing lately? Will you be able to get low rates if you apply for a personal loan? Is it good enough that you will be offered 0 percent interest introductory offers if you apply for a credit card?
Joel S. Salomon, CFA, FSA, Chief Prosperity Officer for SaLaurMor Prosperity Management, and best-selling author of Mindful Money Management: Memoirs of a Hedge Fund Manager, shares this viewpoint:
"I am a former hedge fund manager turned prosperity coach. I teach my clients about 'proper borrowing.' And my answer to your question [is it better to take out a personal loan vs. opening a new credit card] is it depends.
What are the interest rates on each? How much personal loans do you have outstanding and how much credit card balances do you have outstanding?
The interest rate matters because the higher the rate the worse the deal. Also, if you already have personal loans outstanding, say for 30,000, and no credit card balances or credit cards, even if the credit card rate is higher your credit score increases by adding a new credit card."
If you aren't sure, fill out a pre-qualification form online for personal loans and new credit cards, as long as they dont do a hard credit pull. What type of interest rates are you offered?
"The best option to choose depends on your ability to stop the behavior that got you into debt in the first place, if not from an emergency or medical scenario," advises Charnet. "Assuming the situation is under control, playing the credit card zero-balance transfer game will ultimately cost the least amount of money, but the most amount of involvement in the monitoring of dates and repetitive behavior in transferring again and again as you bring down the balance.
Any mistake in timing could ultimately make your situation even worse. The unsecured loan scenario is hard to come by since you are already excessively obligated. Unsecured loans are also at high rates, so the exchange will only be to spread out your payments over many years but, the interest charges may actually be worse than your current situation."
Are you able to curb your spending behaviors, so that you don't end up with more credit card debt to consolidate?
In summary, should you get a credit card or a personal loan? It depends on your situation. We hope this expert advice has helped you consider your options.