Maybe you’re planning to make a big purchase, start a home improvement project, or consolidate existing debt. As you consider potential options for borrowing the funds you need, you might be wondering about credit cards vs personal loans. Both choices are popular, but they certainly aren’t identical. Here we’ll compare the two options across five key characteristics so that you can be better equipped to make a smart financial decision.
First, let’s quickly review how each form of credit works. With a credit card, you can make charges until you hit your predetermined credit limit. As you pay down your balance, you free up more credit to make new charges. With a personal loan, you typically receive a specific amount of money in one lump sum, then pay it back with equal monthly payments at a fixed interest rate over a set period of time.
What is the application process?
With both personal loans and credit cards, a lender may quickly offer you pre-approval after collecting just a few bits of basic information, such as your name and the last four digits of your Social Security number. While pre-approval doesn’t guarantee full approval, it can give you an idea of what terms the lender may offer you. Pre-approval typically triggers a soft inquiry on your credit report, which won’t affect your credit score.
To be fully approved for either type of credit, you’ll usually need to provide your full Social Security number plus information about your age, income and bank account. The lender will verify these details and pull your credit to look at your history of making on-time payments, current and past debts, and your general creditworthiness. This usually triggers a hard inquiry on your credit report, which might impact your credit score. (Visit Prosper’s recent blog about credit scores to learn more about credit inquiries.)
In all, you can typically expect to receive a decision within a few business days, or even sooner in some cases.
How much money can you borrow?
Since both personal loans and credit cards are unsecured—meaning they aren’t backed by any collateral, such as a house or car—how much you can borrow relies heavily on a review of your personal credit history. The better your credit history, the more you are generally able to borrow.
Credit cards: The average credit card limit is about $8,000. If you have very strong credit, your limit may increase to $10,000 or more. On the other end of the spectrum, borrowers with weak credit may have limits of less than $2,000.
Personal loans: Personal loans are usually available in amounts ranging from $500 to $50,000, though some lenders may offer larger loans to well-qualified individuals. Prosper, for example, offers online loans (personal loans) between $2,000 and $40,000.
How can you use the funds?
Credit cards: Because credit cards are widely accepted, you can use them to pay for just about anything quickly and easily. Some people transfer balances from other credit cards to a new credit card (ideally one with a more attractive interest rate) to consolidate existing debts.
Personal loans: Personal loans are equally flexible, if not more so. You can use the funds to pay for a range of needs, such as a special occasion like a wedding, adoption fees, unexpected expense, medical costs or remodeling project. You can also use a personal loan to consolidate other debts. In fact, personal loans often allow you to consolidate multiple types of debts, including credit card debt and medical debt at a lower rate than you might be paying on a credit card.
How much does it cost?
Credit cards: It can be challenging to pinpoint exactly how much your credit card will cost, as it generally depends on two main factors: fees and interest. You can be charged a variety of fees, including an annual fee and late payment fee. As far as interest rates, most credit card accounts have multiple interest rates which are applied in different scenarios. Many credit cards offer purchase interest rates around 15-20%. (Check out our blog post on the cost of credit cards to learn more.)
Personal loans: It’s generally more straightforward to figure out the costs of borrowing money via a personal loan. First, you’ll typically be offered a specific loan amount with a fixed interest rate and an exact payoff date, usually between three to five years. This means that unlike revolving debt on a credit card, you’ll know exactly how much you’ll pay in interest over the life of the loan and when it will be paid off. Interest rates can range from about 5-36%, depending on borrower creditworthiness and loan terms. Most loans also come with application, origination or prepayment fees.
How do you repay the money?
Credit cards: You’ll be required to make a minimum monthly payment, which is often calculated as a percentage of your balance or set at a fixed dollar amount. As long as you make the minimum monthly payment, you can carry a balance for as many months or years as you want, though that can quickly become expensive as interest accrues. You can always opt to pay down more of your balance or pay it off in full each month. If you pay off your balance in full each month before the due date, you won’t pay any interest.
Personal loans: Personal loans are also paid off via monthly payments. Because these loans have a fixed interest rate and set payoff date, each monthly payment is equal in size.
For some borrowers who are disciplined about paying off their balance in full each month, a credit card may be an attractive option. But the truth is, 38% of U.S. households carry balances from month to month, which can be expensive—and gets more expensive the longer you carry the balance. Plus, it may be difficult to avoid the temptation of making further charges and adding to your balance. And if you aren’t able to make the minimum monthly payment, your credit score will likely suffer.
While credit cards are easy to swipe, they can be tricky to manage wisely, which is why many people who know they won’t pay off the full balance at the end of the month opt for a personal loan. For many borrowers, knowing exactly how much is owed each month and when the loan will be fully paid off provides much-needed peace of mind and control over their financial futures.