Personal loans and credit cards both offer a way to borrow funds you can use for any expense. They have many of the same features, but they also have important differences.
With both personal loans and credit cards, you can receive funds from a lender at a specified interest rate. Then you make monthly payments that include principal and interest. As debt, either type of loan can undermine your credit rating if you don't use it responsibly.
Personal loans and credit cards also have a number of key differences to consider, such as their repayment terms.
Key Takeaways
- Personal loans offer funds in one lump sum with relatively lower interest rates.
- Personal loans must be repaid over a set period of time, typically with payments that remain the same.
- Credit cards are revolving credit that give a borrower access to funds as needed.
- Credit scores are key factors influencing approvals and terms for both personal loans and credit cards.
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Personal Loan and Credit Card Approvals
Banks, credit card companies, and other financial institutions will look at a number of factors when deciding whether to approve you for credit. Your credit score is among the more important factors. Your credit score is based on your past credit history, including credit defaults, inquiries, accounts, and outstanding balances. You are assigned a credit score based on this history, and that score heavily influences whether you are approved and for what interest rate.
The three major U.S. credit bureaus—Equifax, Transunion, and Experian—are the leaders in establishing credit scoring standards and partnering with lending institutions to enable credit approvals.
Both paying your credit card balance and repaying personal loans on time can help build your credit score.
Personal Loans
With a personal loan, lenders provide a lump sum amount that you repay over time, typically with fixed payments that remain the same. This is known as an installment loan. A personal loan will have a fixed term as well, usually of two to five years, but sometimes more.
Personal loans do not offer ongoing access to funds like a credit card does, but they usually have lower interest rates, especially for borrowers with a good to high credit score.
A personal loan can be used for any purpose. For example, you can use it to buy new appliances, consolidate credit card debt, repair or upgrade a home, or fund a vacation. Personal loans are typically unsecured, meaning they are not backed by collateral.
Personal loans typically include an origination fee and may have other fees as well. This can add to their total costs.
Pros
Can provide a funding source for large purchases
Usually offers a lower interest rate than a credit card
Provides funds in one lump sum
Has predictable fixed payments
Cons
Typically includes a service fee
and may have other fees that all add up
Does not provide more credit after repayments
Does not offer rewards
How Do People Use Personal Loans?
Investopedia commissioned a national survey of 962 U.S. adults between Aug. 14, 2023, to Sept. 15, 2023, who had taken out a personal loan to learn how they used their loan proceeds and how they might use future personal loans. Debt consolidation was the most common reason people borrowed money, followed by home improvement and other large expenditures.
Credit Cards
Credit cards offer revolving credit in which the borrower typically has ongoing access to the funds.
Revolving credit provides borrowers with access to a specified amount of money, up to a credit limit. But you do not receive that amount in full. Instead, you can use the money as you need it. You only pay interest on the funds you use, so you could have an open account with no interest if you have no balance.
Unlike personal loans, where your monthly payment is usually the same over the entire repayment period, a credit card bill will vary each month. What you will owe will depend on the balance and the interest. You will have a minimum payment, but you usually won't be obligated to pay the full balance. Any remaining balance will be carried to the next month and you will be charged interest on it.
Many credit cards offer benefits like rewards or a 0% introductory period. They offer convenience when making purchases because they can be used at retailers, for online shopping, or anywhere electronic payments are accepted. You may also get an increase in your credit limit over time.
Among their drawbacks, credit cards typically have higher interest rates than personal loans. And some have monthly or annual fees.
Most credit cards are unsecured, but borrowers with poor or no credit history may use secured cards, which require a deposit that's used as collateral.
Credit cards have different ways of accumulating interest. Some credit cards offer borrowers the advantage of a statement cycle grace period in which no interest is charged on borrowed funds. Other cards will charge daily interest, including the final interest charge at the end of the month.
Pros
Ongoing revolving credit balance that only charges interest when funds are used
May offer benefits like 0% introductory interest rates and rewards
Accounts in good standing might get credit limit increases
Cons
Interest typically is higher than on personal loans
Interest and fees can add up an create a cycle of debt if balances are not paid up
If you have a credit card with high interest and are struggling to pay off the balance, you might consider transferring your balance to a card with a lower interest rate.
Other Types of Credit Lending
Beyond personal loans and credit cards, you can choose among other types of loans and credit products. Which type is right for you will depend on your financial situation. Here are some examples:
- Business loans: Business loans can be an option for all types of businesses. Business loan underwriting usually involves the analysis of financial statements and projections.
- Payday loans: Payday loans are short-term loans with very high interest rates. Borrowers use employment paychecks to get cash advances. Payday loans are often considered predatory loans.
- Lines of credit: A line of credit is similar to a loan, but it offers revolving credit like a credit card. A borrower can access funds from the line of credit at any time as long as they do not exceed the credit limit terms and meet other requirements, such as making timely minimum payments.
How Much Would a $5,000 Personal Loan Cost a Month?
The monthly cost of a $5,000 personal loan will depend on the interest rate and term length. You can use an online personal loan calculator to determine the monthly cost of a loan with different terms.
Why Was My Personal Loan Application Denied?
You may be denied a personal loan if your credit score is too low, if your income is not high enough, if you are carrying too much debt, or if you fail to meet any of the lender's other conditions.
Does it Hurt Your Credit to Get a Personal Loan?
Applying for a personal loan may result in a short-term, small hit to your credit score. Once you have the loan, how you make payments can impact your credit score. If you make all the required payments on time, your score can benefit. If you don't make the payments according to the terms, your score can decline.
The Bottom Line
Remember that while both personal loans and credit cards can pay for your expenses, they are not the same. Personal loans have relatively lower interest rates than credit cards, but they must be repaid over a set period of time. Credit cards provide ongoing access to funds and you only pay interest on outstanding balances.
Regardless of whether you choose one or both, your credit score is key to getting approval and favorable terms. Always make certain that you understand a loan or credit card's terms and ensure that you are borrowing from a reputable lender before applying for either.
