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Personal Loan vs. Credit Card: What's the Difference?
Let's say you encounter a big expense that you hadn't expected, such as a home repair or hospital bill. If you don’t have enough saved up to cover the costs, you might wonder what your options are.
Two personal finance tools that could come in handy at times like this are credit cards and personal loans. Which is the right choice in any given situation? To help you make the best decisions for yourself and/or your family, let's explore the differences between a personal loan vs. credit card.
What is a personal loan?
A personal loan is a lump sum that you borrow from a bank. The loan is considered an installment loan. The amount borrowed is fixed and the borrower repays it in fixed, monthly installments over a given period of time, or term. Terms typically range from 3 to 5 years. The lender usually charges a fixed interest rate.
Although the borrower can use the money for just about any purpose, personal loans are sometimes called vacation loans, home improvements loans, debt consolidation loans, and other similar names.
What is a credit card?
A credit card is a type of revolving credit that is issued by banks and financial institutions. The credit card issuer approves for you a line of credit and you can borrow against that. You can use a credit card to buy things — online, by phone, or in person — and even to get cash advances.
As you pay the money back, you can borrow it again and again. This is known as "revolving credit."
If you pay off the card each month, you could avoid paying interest. However, if you carry a credit card balance, interest charges may be applied and added to your balance. The credit card issuer might give you as long as you need to pay off your debt, if you make at least the minimum payment each month. This gives you flexibility in paying off the loan, but making just the minimum payment could stretch out the time it takes to pay off the debt and lead to you paying much more in interest.
Personal loan vs. credit card: Key differences
You can already see that there are some major distinctions between these two forms of borrowing.
Credit cards
Credit cards can provide flexibility and potential perks and rewards, but they need to be carefully managed.
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Credit limit.
You can borrow only what you need, within the bounds of your credit limit—the ceiling set by the card issuer -
Immediate availability.
Once you have the card, funds are available quickly if an opportunity arises or an emergency occurs -
Rewards and benefits.
Many credit cards offer cash back, miles or points toward travel, gift cards, or discounts with retailers -
Budgeting.
Depending on how you use the card, payments may vary from month to month, making budgeting more of a challenge
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Flexible payoff schedule.
The card issuer might give you as long as you need to pay off the card if minimum payments are made on time. However, it's important to have a plan for how you will pay off credit card debt so you can avoid paying interest for a long period of time on your purchases -
Variable interest.
Credit card issuers tend to tie their APRs to the prime interest rate, so the interest rate on a credit card may go up or down -
Intended use.
Credit cards often are used for daily expenses that will quickly be paid off
Personal loans
Personal loans have their own set of unique characteristics.
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Purpose.
A personal loan is usually used to pay a major expense all at once, such as a big home project, a medical bill, or a car repair -
Predictability.
A personal loan provides a fixed amount of money for a fixed period and usually for a fixed rate, so monthly payments are stable. Predictable payments can help with setting goals and budgeting
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Waiting time.
Lenders promise quick approval, usually within only days, but it might take longer to receive the money for a personal loan than to begin using a credit card -
No rewards.
Personal loans don’t offer rewards programs on purchases the way credit cards do
How to choose which is right for you
Credit card or personal loan, or both? The answer depends on many variables, including your debt management strategy, budgeting needs, credit score, and overall goals.
A credit card may be good for day-to-day purchases that will be paid off quickly. Personal loans can be well-suited for large purchases or debt consolidation and allowing payments to be spread out evenly and affordably over time. Acquiring either a credit card or personal loan is a major decision that requires consideration of various factors, including:
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Goal.
If it's a free airline ticket or cash back on your grocery purchases you're after, you might want a credit card. If you're looking to stretch out the payments on a major purchase or consolidate high-interest debt, you might consider a personal loan -
Amount to be borrowed.
The lump sum you receive from a personal loan is fixed, so you must plan carefully for how it will be used. The credit card has flexibility — you can use none, some, or all the available credit -
Interest rate.
If you carry a credit card balance, you'll most likely pay interest. The rates on credit cards tend to be higher than the rates on personal loans. However, if you don't carry a credit card balance from month to month, you might avoid interest charges
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Debt consolidation.
From time to time, a credit card issuer may extend the opportunity to transfer a higher interest credit card debt to a 0% or low Annual Percentage Rate (APR) account for a set period. These offers could be used for debt consolidation. A personal loan also can be used for debt consolidation. There will be no 0% introductory interest rate on a personal loan, but the rate will remain the same. With a credit card balance transfer, the rate will increase once the introductory period ends. To decide which option is better, you’ll have to compare the interest rates, the amount you can afford to pay each month, and the time you’ll need to pay off the loan -
Predictable payments.
Monthly payments on a credit card balance will vary based on how much you use the card and its variable interest rate. A personal loan might provide more predictability for budgeting purposes
Credit cards and personal loans at TD
Personal loans and credit cards can be useful financial tools that can help you with debt management and other personal finance issues. Both may require you to pay interest; however, the payments on a personal loan are fixed each month, while credit card payments vary based on usage. Whichever way you decide, TD Bank has options available to suit your needs.