Common financial wisdom says that if you want something, you need to save for it. That’s great advice – if you actually have the time.
In reality, sometimes we need extra money we just can’t wait for. Whether it’s an emergency expense, a once-in-a-lifetime business opportunity or the chance to fund the wedding of your dreams, there’s nothing wrong with going into debt if you have the right reasons.
But taking on debt is a dangerous game no matter how justified, and plenty of people start out with a little just to end up with a lot. It’s a death spiral that’s all too easy to slip into: taking on debt, struggling to keep up with expenses and falling even deeper into debt to keep up. That’s why it’s so important to choose the right debt vehicle.
When it comes down to it, your two options are a personal loan or a credit card. Both have their uses, and your specific financial situation will determine which one you should choose. Read ahead to find out which one is the best fit for you.
A personal loan is an unsecured loan, which means that it’s not tied to any type of collateral, like a mortgage or car loan. It’s also a fixed loan, which means borrowers pay in fixed installments over a predetermined amount of time. Consumers typically take out personal loans for weddings, businesses, debt consolidation and emergencies.
Most personal loans have a limit of $35,000, although there are loans available for $100,000. The credit limit you’re eligible for depends on your credit history and assets. If you need a loan of $50,000, your best bet is a personal loan. Most credit cards only have a credit limit of about $11,000 if you have a credit score of 781 or higher.
If you have a high credit score, you can qualify for a personal loan with an interest rate in the single digits. Not sure if your score is eligible? Get a few pre-approved offers to see what you can get. Make sure to choose a company that will only perform a soft credit check to give you an offer – a hard inquiry will go on your credit report and ding your score for a year.
Personal loans are like auto or student loans – they have a set payoff date and term length. Most have three or five-year terms. Unless you default or refinance, you’ll pay off the debt within that set time. If you’re the type of person who avoids paying off your entire credit card balance, then a personal loan might be better for you. It will help you stay on track and allow you to be debt free faster.
One huge benefit of personal loans is that if you find one with a fixed interest rate, the rate won’t change for the life of the loan. Credit card interest rates vary, so by choosing a personal loan, you know what kind of interest you’ll be paying over the life of the loan. Some people also choose personal loans with variable interest rates, which will also change depending on the market. These will have lower introductory rates, but people living paycheck-to-paycheck might struggle to handle fluctuating payments.
Some experts also say that personal loans look better on your credit report, because they don’t have a credit limit the same way that credit cards do.
A credit card is a line of credit you can access whenever you want. When your application for a card is accepted, you’re given a line of credit based on your credit score. A credit line gives you access to more money in a given payment period. Payments are typically due monthly, and failure to pay in full will result in a balance that carries over to the next month.
Lee Huffman of Bald Thoughts said he recommends credit cards instead of personal loans if you can find one with a 0% APR. Some credit cards have an introductory 0% APR on all purchases, ranging from 2 to 21 months. If you’re able to pay off the balance within that time frame, then you could save hundreds on interest.
If you fail to pay off the loan in that time, then you can try transferring the balance to another card with 0% APR. You might have to pay a 3-4% balance transfer fee, but that can still be a better deal than keeping the balance on a card with a 15% APR. Transferring balances can be a hassle though, so aim to pay it off within the initial period.
However, the intro offer is only good if you don’t have any late payments. If you make one late payment, then the 0% interest rate can go away immediately and you’ll start paying a higher interest rate. Use a calendar reminder so you don’t forget about the payment.
One of the downsides of credit cards is that there’s no fixed payoff date. As long as you keep making the minimum payment, the balance will stay on the card where you’ll pay significant interest fees.
But credits cards are also easier to apply for. You can find a credit card online within minutes and hear back instantly. There are a wide array of credit cards available, and many come with perks that you’ll never find with a personal loan.
For example, one benefit of credit cards is rewards offers, like cash-back or airline points. If you have to buy $5,000 worth of appliances for your new house and use a credit card with 1% cash back, you’ll earn $50. If the card has 2% cash back, that’s $100 in rewards. If you choose an airline card, you could earn a free flight or hotel stay while you’re paying off your card.
When you’re choosing a credit card, compare all the fees they have to make sure your transaction won’t be costing more than you think. Many issuers make their profits in the fine print, so don’t be afraid to dive in and make sure you know what you’re getting into.
How to choose
Still not sure which one to choose? Here are a few ways you can decide.
Decide how much you need. The type of credit vehicle you should apply for partially depends on how much money you need. If you only need $1,000 for a new water heater, a credit card is better. There’s no point in applying for a personal loan for a sum that small. If you need $15,000 to start a new business, then a personal loan is likely your only option.
Compare rates. Get a few pre-approved personal loan offers to see what kind of rates and terms you qualify for. Then, find the best 0% APR credit card available and apply for it. If your credit card application is accepted and you can pay off the amount within the time frame of the special offer, then go with the credit card. If you’re worried about running out of time, choose the personal loan.
- Decide how you need the money. Personal loans and credit cards give you money differently. A lender who gives you a personal loan gives you a lump sum that you can do whatever you want with. You can use it for your wedding, to pay off other debt or to take a vacation. A credit card allows you to charge money on the card, but it doesn’t give you cash. For example, if you need to pay a contractor, they might not accept a credit card and request a check instead. This can be true with rent payments as well.
- Find out your credit score. In general, only those with very good or excellent credit can qualify for low-interest personal loans. Otherwise, you’ll be stuck with a personal loan with a high interest rate. But those with good credit scores can sometimes find 0% APR credit cards. Take a look at your credit score and do some research on what kinds of personal loans or credit cards you’ll qualify for.
- Consider your credit utilization ratio. If you’ve been using a credit card but suddenly need to charge more than usual, make sure to check your credit utilization ratio first. Credit utilization is how close your balance gets to your credit limit, and anything over 30% has a chance to hurt your credit score. If racking up more credit card debt would put you over that threshold, consider a personal loan instead. Personal loans use installment debt rather than revolving, which means your score will stay in good shape as long as you make the payments.
The bottom line
In general, there’s no one-size-fits-all answer. Look at your personal situation to determine whether a personal loan or credit card is right for you. Call your bank or credit union to see what options they have or look at the pre-approved credit cards you get in the mail. The perfect answer might be right under your nose.