Credit Card vs. Personal Loan: Which is Better to Fund a Big Purchase?
If you’re looking to make a large purchase but don’t have enough money to do so, you’ll need to borrow some money to make the purchase.
You might wonder whether you should use a 0% APR credit card offer or a personal loan to cover the expense.
Both have their advantages and drawbacks and are best for different situations.
The Case for Using a Personal Loan
Personal loans are good for very large purchases that will take years to pay off.
Where to get
You can get a personal loan from a large variety of lenders. Many banks and credit unions will offer personal loans.
As a bonus, existing customers can often get approved more easily and pay less interest. Banks like having their customers do all their banking in one place, so they offer these kinds of incentives all of the time.
Many online lenders also offer personal loans.
Online lenders tend to offer special twists on the traditional formula, such as look at factors other than your credit when making a lending decision.
Credit score required
Personal loans generally require good credit to qualify for.
One thing to keep in mind is that there are two types of personal loan: unsecured and secured personal loans.
Secured personal loans are much easier to qualify for, but require that you give the lender some form of collateral. This increases your risk but can help you get the loan more easily.
Personal loans charge more interest than a mortgage or auto loan, but much less interest than most credit cards do.
If you opt for a secured personal loan, you’ll pay less interest than if you’d chosen an unsecured loan. The bank takes on less risk with a secured loan, so it does not need to charge as much.
Loan limits and repayment terms
Personal loans are very flexible. Some lenders will let you borrow as much as $100,000 and will give you as long as 7 years to pay the loan back.
This means you can use a personal loan to cover nearly any expense unless you’re looking to spend hundreds of thousands of dollars.
The amount that you borrow and the repayment term determines the size of your monthly payment.
Longer terms result in lower monthly payments, but a higher overall cost.
A shorter repayment term means you’ll pay more each month, but less overall.
Try to strike a balance where you have a manageable monthly payment but don’t pay more interest than necessary.
Some lenders take weeks or more to get the money to you after you apply for a personal loan.
Others get the money to you in just days. Take this into account when you decide which lender to use.
Lenders who get you money quickly tend to advertise that fact.
Two of the most common fees charged by personal loan providers is the application fee and origination fee.
Applications are usually flat amounts ranging from $20-$50. Origination fees are larger, usually a percentage of the amount you borrow.
Keep these fees in mind since they add a lot to the cost of the loan.
Common Personal Loan Fees
|Type of fee||Typical cost|
|Application fee||$25 to $50|
|Origination fee||1% to 6% of the loan amount|
|Prepayment penalty||2% to 5% of the loan amount|
|Late payment fee||$25 to $50 or 3% to 5% of monthly payment|
|Returned check fee||$20 to $50|
|Payment protection insurance||1% of the loan amount|
What if you miss payments?
Missing a payment on any type of loan will result in fees and a hit to your credit, so you should avoid it if possible.
Some personal loans, however, offer unemployment protection.
If you lose your job, you can stop making payments without hurting your credit.
Interest will continue to accrue, but your credit won’t be affected.
The Case for Using a Credit Card
Credit cards make a compelling case as the preferred payment method.
Many offer big sign-up bonuses for people who apply for their card.
One of the most common is the 0% APR introductory period where you won’t pay interest on purchases for the first 12-24 months you have the card.
After that, you are charged interest at the usual rate.
Where to get
There’s a huge number of credit card providers that offer 0% APR deals for new cardholders.
You can simply choose your preferred issuer and check whether any of their cards are currently offering the deal.
Credit score required
The credit cards that are the most likely to offer amazing rewards programs or low interest rates will generally require above-average credit.
Lenders would hesitate to give interest-free loans to people with anything but great credit.
That means you’ll probably have a harder time getting a credit card with a lower APR than a personal loan.
The benefit of 0% APR credit cards is obvious. You don’t pay any interest at all.
The downside comes when the introductory period ends. If you don’t pay off the full balance by the time the introductory period ends, the card will begin charging its usual interest rate.
Given the fact that many card charge interest rates as high as 20%, this can easily eliminate any of the savings you may have gotten during the interest-free period.
Credit limits and limited time APR periods
Credit cards come with much lower limits than personal loans do. Even premium cards won’t offer much more than $20,000 in credit to customers with excellent credit scores.
The 0% APR period on most cards is also rarely longer than 18 months, though some might be as long as 2 years. This is much shorter than the 7-year term some personal loans offer.
Time it takes to receive the card
It usually takes a week or two from the time you apply for a card to the time that it arrives in the mail.
If you need to make a large purchase immediately, that can be an issue. If you have some time to plan, you shouldn’t have trouble waiting the week or two.
Some credit cards charge an annual fee to keep the account open, but you should be able to find a card with no annual fee.
If you do choose one with an annual fee, make sure that the benefits of the card will justify this added cost.
Typically, if you're seeking a credit card with a 0% APR introductory period, these types of cards don't usually have an annual fee.
What if you miss payments?
Credit cards are not very forgiving when it comes to missing payments.
You’ll have to pay a late fee for each missed or late payment and your credit score will take a hit.
Personal Loan vs. Credit Cards
Given their differences, personal loans and 0% APR credit card offers excel in two very different situations.
Credit cards are best for smaller purchases that you can pay off before the introductory period ends. Personal loans should be used for larger purchases that will take a while to pay off.
A real-world example
Consider the following example:
You want to do some home improvement work, and expect it to cost $10,000. You can put $600 towards the loan payment each month. That means you can pay the loan in full in 17 months.
You decide to get a 0% APR credit card with an 18-month introductory period. You put the purchases on the card and you make the monthly payments for 17 months and the loan costs you exactly $10,000. You pay no interest.
Had you instead take out a 2-year personal loan with an interest rate of 5% you’d have paid only $439 per month. However, you would have paid a total of $10,529.13, more than $500 in interest.
Using the card saved you a good amount of money.
How each affects your credit
Personal loans and credit cards affect your credit differently.
Personal loans will cause an immediate drop in your credit score as your debt and credit utilization rise.
As you pay the debt down, your score will increase, eventually rising above where it was when you started. A few years after you pay the loan off, it will fall off your credit report and stop affecting your score.
A credit card will have a similar effect at first but will continue to benefit your score for as long as you keep it open, even after you pay it off.
Also, consider that your credit score looks at your credit mix.
If you’ve never had a personal loan before, but have had credit cards, getting the personal loan can boost your credit.
Which Should You Use?
Ideally, you won’t need to turn to a loan at all, but if you do need to use one, deciding might be hard.
Just remember that credit cards are best for short-term loans. You lose all of the benefits if you can’t pay the balance in full before the promotional period ends.
You should use a card only if you can pay the debt off in less than 18-24 months. Personal loans should be used for any very large purchase or one that will take longer to pay off.
The best alternative to taking out a loan to make a big purchase is to save, but there are some other options.
You can decide to tap your home equity line of credit (HELOC) or sell some possessions to fund your purchase for example.
How to Save for Large Purchases
There are a few ways to can save for a large purchase.
Online savings accounts
Online savings accounts are a great way to save for large purchases.
They charge low fees and pay high rates of interest.
It’s also easy to set up automatic deposits or transfers to them, letting your savings happen automatically.
CDs are good if you know exactly when you’ll need to make a purchase.
You can invest money in a CD that matures right before you’ll need to make the purchase.
That lets you take advantage of CDs’ higher interest rates without worrying about their lack of liquidity.
Set up a budget
For any predictable, but large, expense, you should set up a budget.
For example, everyone will need to replace their current car eventually.
If you budget even just $50 a month to go towards a new car fund, you’ll have a lot of money when your current card gives out and you need a new one.
Anticipating large expenses is the best way to avoid needing to go into debt to pay for them.