*Contributed by Shiv Nanda of MoneyTap.com.
Credit cards and personal loans are both good solutions for financing regular expenses as well as unexpected ones. Both products are basically unsecured loans that do not require collateral backing, and you can repay them over time.
So, how do you choose which one to get?
It’s best to use a loan for long-term financing and put ongoing payments or purchases on a credit card that you can pay off in full every month. Let’s look at these in a little more detail to understand why.
How Do Credit Cards and Personal Loans Work?
- Credit Cards – A credit card is a revolving loan, where the lender provides you with flexible access to funds. You are given a credit limit, which is the maximum amount you can use. Every repayment will recharge or top up this limit.
You can choose between paying a minimum percentage of your monthly bill, higher amounts, or even the complete balance. You will incur interest if you rollover any part of the balance to the next month, and late fees if you don’t pay by the due date.
- Personal Loans – A personal loan, on the other hand, is a one-time agreement between you and a bank or non-banking financial company. You receive a lump sum payout after approval, and need to repay this amount in fixed monthly installments or EMIs spread out over a pre-decided tenure.
Whether you use all of this money, part of it, or don’t touch it at all, you will be paying interest on the complete loan amount, and late fees if you miss or delay a payment. However, interest rates are usually lower than credit cards.
Using a Credit Card or Personal Loan for Debt Consolidation
Both options can help you bring down your debt, as long as you use them correctly:
- If you can get a credit card with a lower interest rate than your existing loans or cards, transfer the balance over to save money on interest as well as avoid late fees while trying to keep track of multiple payment due dates.
- If you think you may need a longer repayment term to clear your debt, a low-interest personal loan would be more effective, but make sure to check whether there are any penalties for paying more than the fixed EMIs.
How to Decide between Personal Loans and Credit Cards
To figure out which loan option is right for you, consider your financial needs, budget and repayment abilities. Here are some questions to ask yourself at this stage:
- How much money do you need?
Avoid borrowing more than you can repay, especially with fixed-interest loans.
- Will you be using a loan for cash?
Interest rates are usually much higher for cash withdrawals through a credit card.
- How quickly can you clear your debt?
Credit cards are good for short-term financing, but expensive in the long run.
- Is your credit rating good or bad?
Poor credit scores mean higher interest rates, so consider using bad credit loans.
- Is the borrowing process flexible?
With revolving credit, you can use as much as you need and keep repaying it.
- What are the potential risks?
If you’re prone to overspending, credit cards could easily lead you into a debt trap!
You can also combine the benefits of both loan products with a personal line of credit. Along with the flexibility of revolving credit, there are no additional charges for prepayment or cash withdrawals, and you can borrow against your credit limit 24/7.
About the author: Shiv Nanda is a financial analyst who currently lives in Bangalore and works with MoneyTap, India’s first app-based credit-line. Shiv eats, breathes and sleeps finance, to the dismay of friends who’ve endured unsolicited advice on their investment choices, budgeting skills, or lack thereof. Luckily for them, Shiv has diverted this energy toward writing about various financial topics online. He loves it when people actually ask him for advice, so email him your questions at firstname.lastname@example.org. He’ll try not to get carried away with the answers!