Personal Loan vs. Credit Card - What's Right for Me?

Two of the most common options for borrowing money are taking out a personal loan or using a credit card. But what are the pros and cons of each, and how do you know which could work best for your financial situation?

Here’s a closer look at the differences between credit cards and personal loans so you can compare them and decide which works best for you.

What is the difference between a personal loan vs. a credit card?

A personal loan is a lump sum of money that is borrowed from a lender that you can spend as you wish and pay back in fixed monthly installments over a set period of time.

A credit card is a financial tool that allows you to borrow money up to a certain limit, known as your credit limit, to make purchases directly with merchants. It operates as a revolving line of credit, meaning you can borrow up to the limit, repay and then borrow again as needed. You’re required to pay at least the minimum balance each month, but it's possible to avoid paying interest charges on purchases if your card offers a grace period and you pay the full amount due. Keep in mind that cash advances don’t have a grace period, so interest starts accruing from the day of the transaction.

A credit card is traditionally a plastic card with the cardholder’s name and expiration date embossed on it. The physical card is used for in-person purchases by tapping, swiping or inserting it into a card reader. However, credit cards can also be linked to a digital wallet like Apple Pay or PayPal that allows for contact-free and convenient online transactions.

Credit cards and personal loans are issued by the financial services company or bank that is lending you the funds — money you agree to pay back, plus interest and other agreed-upon charges. Personal loans usually have fixed interest rates with daily simple interest, while the initial interest rate on a credit card is based on the applicant’s creditworthiness and can be fixed or variable. Variable means the interest rate can change based on the index the issuer discloses to the applicant, and fixed means the interest rate will stay the same.

Personal loans are repaid over a set period of time in monthly installments. Credit cards could be repaid over time, too, since only the minimum payment is required, but should ideally be paid off monthly to avoid interest charges. Remember that paying only the minimum on your credit card each month could take years to pay off the balance in full. It’s best to pay more than the minimum whenever your budget allows to avoid high interest charges and pay off your debt sooner.

How do personal loans work?

• Most personal loans are considered installment loans since you pay the loan back in equal amounts via regular monthly payments called “installments."
• Personal loans usually have a fixed interest rate, which means the rate will stay the same for as long as you have the loan.
• Many fixed-rate installment loans are calculated using daily simple interest.
• Unlike a credit card, you don’t gain access to more credit as you pay off your personal loan. Your balance simply goes down as you make payments.
• The actual length of a personal loan term can vary between 12 to 60 months or longer depending on the lender.¹
• Some loans allow you to pay off the balance early without any prepayment fees. Read the terms and conditions of the personal loan offer carefully.

Pros and cons of personal loans

Pros

• Fixed repayment schedule: A personal loan typically comes with a fixed repayment schedule, allowing you to budget and plan your finances more effectively.
• Lower interest rates: Compared to a credit card, a personal loan could offer a lower interest rate, especially if you have a good credit score.
• Lump sum: A personal loan provides a lump sum of money up front, which may be beneficial for large expenses such as home renovations or debt consolidation.
• Builds credit history: Paying your personal loan responsibly could build your credit history and potentially increase your credit score.

Cons

• Fees: Some personal loans may come with an origination fee or prepayment penalty, which may add to the overall cost.
• Fixed amount: Once you've spent the loaned amount, you cannot access additional funds without applying for a new loan.
• Overborrowing: Since personal loans are typically issued in a lump sum, there may be a temptation to borrow more than necessary, which can lead to more and/or unmanageable debt.

How do credit cards work?

• When you use a credit card, you are borrowing the issuer’s money to buy things and then paying the money back later, either in full by the due date or partially over time, in which case you’ll be subject to paying finance charges on the unpaid balance.
• Credit cards give you access to a revolving line of credit. The amount you haven’t spent yet is called available credit, while the amount you have spent and need to pay off is called your balance.
• As you pay off your balance, your available credit is restored. Both your available credit and your balance can be carried over month to month, but you will have to pay finance charges if you do not pay the balance in full. This is why credit card debt is considered revolving debt.
• It’s important to try to pay your balance in full and on time each month. Credit card debt is usually subject to compound interest, which can add up quickly. What this means is that your minimum monthly payment is calculated by adding your previous unpaid balance + interest on that balance + any new charges.
• Keep in mind that if cash advances and balance transfers don’t qualify for a 0% intro or promo Annual Percentage Rate (APR) offer, interest charges will kick in on the day you make the transaction.
• Your credit score and other factors can influence the (APR) on your credit card so it’s best to ensure your credit is in good standing if you want to get a lower rate.

Pros and cons of credit cards

Pros

• Flexibility: Credit cards offer flexibility in terms of spending, allowing you to make purchases up to your credit limit and pay them off over time, although it’s best to pay off your bill in full every month to avoid paying finance charges.
• Rewards and perks: Many credit cards come with rewards programs, offering cash back, travel rewards or other incentives for spending, but this perk is only beneficial if the credit card is managed responsibly, and the annual fee doesn’t outweigh the value of the rewards.
• Build credit history: Responsible use of a credit card may help build your credit history, which is essential for future transactions like car loans or home mortgages.

Cons

• High interest rates: Credit cards often come with high interest rates, especially for people with less-than-perfect credit scores. Carrying a balance may also lead to significant interest charges over time.
• Potential for overspending: The ease of swiping a credit card could lead to overspending if not managed carefully, potentially resulting in unmanageable debt.
• Annual fees: Some credit cards may have annual fees, reducing the overall value of rewards and perks, especially if you don't use rewards often.

Is it better to use a personal loan or a credit card?

Personal loans and credit cards are used for different purposes and meet different financial needs. Here are three things to consider when choosing which to use and when:

1) Type of purchase

Personal loans are typically used for larger long-term purchases that the borrower intends to pay off over time. By taking out a loan, the borrower can keep the cost separate from other debts and credit accounts. Common uses include medical bills, auto repair bills and home improvement. Another popular use is debt consolidation.

Credit cards can be ideal for smaller short-term expenses that can be paid off quickly. Common uses include gasoline, dining out and clothing.

2) Availability of funds

Personal loans — The availability of funds may not be immediate, but some lenders can provide a same-day response to an application. If approved, they might also disburse the funds the same day. Most personal loans are paid out in a lump sum and delivered via paper check or direct deposit to your bank account.

Credit cards — The availability of credit depends on your spending and payment habits. If you have enough available credit to make a purchase, the funds should be accessible right away. All you need to do is swipe the card or provide your account information if you’re shopping online.

3) Monthly budgeting

Personal loans — Most personal loans have a fixed interest rate, and payment amounts throughout the life of the loan. This makes the effect on monthly cash flow more predictable and may make it easier to manage a monthly budget.

Credit cards — While some credit card APRs can be fixed, it’s more common to have a variable rate.¹ If your rate does change, the rising interest costs could increase your monthly payment for new transactions that are subject to the new APR.² The minimum payment for credit cards can also fluctuate based on how much you use the account and what your current balance is each month. This calculation is based on the total amount you owe, including finance charges that accrue because you did not pay your total balance.³ If you continue to charge purchases, or suddenly add a large purchase to the account, the minimum payment could get higher and make it harder to budget.⁴ Many card issuers are now offering features like “buy now, pay later” programs that allow you to split large purchase transactions into separate payments. Be sure to read the fine print to understand all terms and conditions before you decide to go this route.

How do personal loans and credit cards affect your credit?

Personal loans and credit cards may significantly impact your credit score differently. When you apply for either, a hard inquiry is made on your credit report, which may temporarily lower your score.

Making consistent on-time payments each month could positively influence your credit history and account for a substantial part of your credit score. On the other hand, if you miss even one payment or carry a high credit card balance, it could negatively affect your credit score. While personal loans are installment loans with a fixed repayment term, credit cards offer a revolving credit line. Your utilization rate, which is how much credit you use compared to what you have available, is crucial in managing a revolving credit line. That’s why it’s a good idea to keep your utilization low to maintain a good credit score.

Final takeaways

At the end of the day, the core difference is that a personal loan has a definite end date and is often used for a specific purpose, like getting out of debt. A credit card is an ongoing, general purpose line of credit that will last for as long as you keep the card and stay current rather than be past due.

A credit card might be the way to go for smaller everyday purchases. A personal loan could be a better option for debt consolidation, major purchases and life expenses.

Sources:

1. DeNicola, Louis. Are Credit Card Rates Fixed or Variable?
   
2. Irby, Latoya. “Learn When Banks Can Increase Credit Card Interest Rates.” TheBalance.com
   
3. Hipp, Deb. “What You Need To Know About A Debit Card Minimum Payment.” CreditKarma.com
   
4. Konsko, Lindsay. “Why Does My Credit Card Minimum Payment Keep Rising?”. Nerdwallet.com. (accessed December 19, 2017).
   
   

*This article has been updated from previous postings between 2019-2023. Joe Guida, Matt Diehl, and Kim Gallagher contributed to previous versions of this article.