If you’re planning to buy a big-ticket item, or want to do some work on your home, you might be considering using a credit card or taking out a personal loan. But which is better suited to your purchase, and what are the differences between the two types of lending. Canstar explores credit card and personal loan debt:
Essentially, credit cards and personal loans allow you to borrow money. Both have fixed interest rates, debt limits and fees. And both have ordered repayments plans. Should you fall behind on your repayments, either type of credit can also cause some pretty serious damage to your credit score.
But the two also differ in ways that can sometimes mean the difference between manageable repayments and out-of-control debt.
Personal loans vs credit cards
What is a credit card?
Credit cards offer you a set amount of credit. In essence, it’s an unsecured revolving line of credit, up to a specific limit. You have a certain period to repay the money owed in full, or you have to repay what you owe plus interest.
For some cards, interest is charged on all purchases and transactions from the day the transaction is made. The credit limit on your card depends on factors such as your credit score, income and your lender.
Credit cards can be extremely useful for people who have tight control of their finances. If you choose the right credit card for your spending profile, you can use credit cards to your advantage, and earn cash or rewards for their use.
The interest-free periods offered by credit cards can also provide a useful financial buffer during periods of restricted cashflow. For example, should you run out of cash before payday.
However, it’s worth remembering that it can be easy to fall into a trap using such a ready form of credit. So make sure you keep a close eye on any debt you accumulate. And endeavour to pay down your debt each month, rather than just making minimum repayments and accruing interest charges.
What is a personal loan?
A personal loan is a more structured and stable form of borrowing money. A personal loan allows you to borrow a specific amount of money and then repay the debt plus interest in equal instalments over an agreed term. The amount you can borrow with a personal loan varies from lender to lender. It can range from a few hundred to thousands of dollars.
Many personal loans allow the borrower to make extra repayments. Every dollar you repay above the required repayment shortens the life of the loan, as well as the overall cost.
There are two different types of personal loans: secured or unsecured:
- Secured loans use an asset, such as a car, as security against the debt. If you don’t repay the loan, the asset is sold to cover the money owed
- Unsecured loans are not secured against any asset and tend to come with higher interest due to the increased risk for the lender. If you default on the loan, your lender may take you to court to recover their money
Differences in interest rates
The amount you pay in interest on a personal loan compared to a credit card will usually be lower. You can lower it further by providing security on the personal loan, in the form of a car or property, for example.
Credit cards generally have higher interest rates than personal loans. And because the debt revolves – changes each month according to your spending and repayment history – it’s easier to lose track of what you owe. This can result in bill-shock and unexpected debt, which can lead to compounded interest charges.
Differences in repayments
Repayment systems for personal loans and credit cards differ greatly. Personal loans work to a set fixed term, from a few months to a few years, with fixed repayments.
Credit cards give your the option to pay off either all or some of your debt each month. If you clear all your debt from the billing period, you won’t be charged interest. If you only pay the minimum, interest will be charged on all outstanding transactions – plus any fees or interest – from the moment they were charged to your card account.
Temptation to spend
Personal loans don’t carry the same temptation to spend as credit cards. Kiwis are big spenders when it comes to flashing the plastic, and the attractiveness of a credit card is what makes it so dangerous: it’s so easy to use. All the little purchases can quickly add up on a credit card and leave you weighed down with debt. As a personal loan is fixed, you’re only able to spend to your planned limit.
Both have their place
So what should you go for if you need to borrow funds? It depends on the purchase you want to make. A personal loan is generally cheaper if you’re after a bigger single one-off purchase, like a car, or to renovate your kitchen. And their fixed terms and repayment schedules make them easier to budget for. However, especially for smaller sums, they don’t offer the same flexibility of lending or repayments as credit cards.
Ultimately, whichever you choose, your choice of debt provider should revolve around how much you can afford to borrow, your proposed repayment schedule and the amount of interest you are comfortable with paying. If you do your homework and shop around, both can provide similar rates and fees if you don’t incur penalty charges.
To help you compare the different loan providers and rates on the market, Canstar’s expert research panel reviews personal loan and card providers each year and awards the best our Gold Star ratings. To compare personal loans just click on the following link.
Or to compare interest rates, features, and fees for credit card, just click this button:
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