Should You Get a Personal Loan or Use a Credit Card?
Since interest rates on personal loans are generally lower than on credit cards, you may be wondering why people need credit cards at all? However, personal loans have their limitations, making them more suitable for targeted spending – usually for incidentals, home renovations, or debt consolidation.
What is a Personal Loan?
Personal loans are installment loans, which means you get a lump sum right away, but you have to pay fixed monthly payments and interest rates. This is in contrast to a revolving loan (ie credit card), which allows you to borrow more at any time without a fixed schedule for repaying the balance (although there are small minimum payments that come with late fees).
Lump-sum loans range from USD 1,000 to USD 50,000 and are due to be repaid within 12-60 months. Your credit rating determines the interest rate, which averages 9.5 percent, compared to around 16% for credit cards, according to Bankrate .
The downside of personal loans
- Since loans to individuals have a fixed installment plan, you will have to pay the same payment every month without any flexibility in order to pay less. With less flexibility, you take on more risk of debt – if you’re already using the loan to pay unexpected expenses like car repairs, who can say the car won’t break down again?
- Personal loans may have lower interest rates than credit cards, but they also include significant “processing fees” included in monthly payments, which can offset potential savings. They usually range from one to eight percent of the Nerdwallet loan amount . Make no mistake, it’s money straight from your wallet: the 5% commission on a $ 20,000 loan will set you back $ 1. (Not all lenders charge a fee for making personal loans, but they may limit the amount you can spend.)
- If you have an average or low credit rating, you probably won’t get an interest rate much better than on a credit card. Without the advantage of a lower interest rate, loans to individuals are simply a less convenient form of credit.
Before taking out a personal loan, calculate and make sure that it suits you. In some cases, a credit card may be the best option, especially for small loan amounts.
What are personal loans for?
Personal loans make the most sense when you have a stable income and want to pay fixed one-time expenses that you can cover with more time to repay them. Most often this includes:
- Debt Consolidation: You can potentially consolidate all your debts by using a lower interest rate on your personal loan to save on interest expenses. Ideally, this scenario will allow you to pay off the debt faster.
- Emergencies: If you’ve used your emergency fund, a personal loan may cover unexpected car repairs or a lost computer not covered by insurance. However, refrain from using personal loans for medical expenses, as there are a number of better options that you should look out for first .
- Home Improvement : This can be a win-win as you borrow money to add value to your home by using a loan to cover expenses. Also, since a home equity loan puts you at risk of losing your property if you cannot make the payments, a personal loan may be a safer option.