Personal Loans v. Credit Cards: Which Debt is Better?
There are many reasons you might need a quick infusion of cash. Maybe to pay for a wedding, a vacation, or a home improvement project, or deal with a medical or financial emergency. If you don’t have the money you need in your savings account, you’re not alone. A recent CNBC poll found that a whopping one in three Americans has $0 saved.
Your best options for fast money are credit cards or personal loans, but personal loans are likely to cost you a lot less over the long haul. They also look better on your credit report. Here's what you need to know.
How credit cards work
Credit cards are convenient. But they’re also expensive — their interest rates and fees tend to be on the high end. They’re also not great for your credit score if you have a lot of credit cards, or a heavy amount of credit card debt.
Credit cards are considered “revolving debt.” What that means: You have a credit limit, but you don’t just take out the loan one time, and you have no specific due date to pay it all off as long as you’re making your monthly payments on time. You can add to the debt at any time when you use your credit card to buy things.
Revolving debt is one of the worst types of debt for your credit — the more of it you have, the lower your credit score.
In addition, your credit score is strongly impacted by something called the “credit utilization ratio.” This is the ratio of how much credit card debt you have vs. how much is available to you. Ideally, you shouldn’t have more than about 30%.
About a third of your credit score is tied to your credit utilization ratio—so the more you use your credit cards, the lower your score is.
How personal loans work
Personal loans are considered “installment debt.” This is a type of loan where you take out a single lump sum, and pay it off in regular installments until it’s gone. You have a specific deadline of when that’s supposed to happen, and you don’t add to the loan by using it to buy things.
In other words, it's predictable debt.
Personal loans can have a positive effect on your credit for a number of reasons. First, paying the loan every month can help you build a strong credit record. And unlike a credit card, it doesn’t come with the added temptation to keep spending.
In addition, installment debt is less harmful to your credit score than revolving debt. If you have mostly credit card debt, consolidating some of those credit cards with a personal loan can also help to diversify your debt — which gives you another boost.
Check out our current picks for the best deals on personal loans.
Which one is right for you?
It depends. Credit cards are useful for everyday spending, but their interest rates tend to be a lot higher than personal loans — and it’s generally not ideal to rack up thousands of dollars in debt on them.
If you need a lot of cash quickly for a big expenditure, like a wedding or a home remodel, it may be a better idea to take out a personal loan.
The bottom line? Consider what you’re using the loan for, the interest rate and terms, and the impact on your credit score before you take out a loan or increase your credit debt.
If you're interested in a personal loan, we suggest you check out Citizens Bank. In addition to competitive interest rates, they offer fast approval and quick fund disbursement. You may also qualify for discounts that could score you a lower interest rate.