Personal Loan Vs. Credit Card: Which Should You Use?

Knowing when to take out a personal loan or when to use your credit card can prevent financial challenges down the road. Both are useful for handling unexpected expenses or larger purchases, but there are some major differences in how you repay what you borrow.

If you need a lump sum of money to cover a project or to pay off high-interest credit card debt, consider a personal loan. However, a credit card is the better option for smaller, everyday purchases.

Personal loans vs. credit cards

A personal loan provides a lump sum, minus origination fees (if applicable). You make fixed monthly payments until your balance is paid. Loans are typically used for a large expense or debt consolidation.

A credit card is a revolving line of credit, meaning you can repeatedly borrow funds up to a preset threshold called your credit limit. So, it’s typically best for ongoing daily purchases.

Key differences between a personal loan and a credit card

When comparing personal loans and credit cards, check repayment terms, interest rates and how you access your funds. These can be important factors that help determine which is better for the expense you’re paying for.

While there are many differences between a personal loan and a credit card to consider, there are also some important similarities. Both allow you to borrow money that you must repay in monthly installments. Inconsistent or missed payments can damage your ability to borrow more in the future — or even qualify for housing or jobs.

When to use a personal loan

Personal loans typically have lower interest rates than credit cards and are designed for large, one-time expenses.

Taking out a personal loan makes the most sense when you know you can make the monthly payments for the full length of the loan. You can use a personal loan calculator to estimate your payments based on loan term and interest rate.

A few common reasons to take out a personal loan include:

• Consolidating high-interest debt.
• Paying unexpected medical bills.
• Completing home improvement projects.
• Covering wedding costs.

We recommend against using personal loans for smaller expenses that you could pay from your savings or by the end of your credit card’s grace period, since there’s no way to avoid interest with a personal loan.

Pros and cons of a personal loan

Knowing the pros and cons of a personal loan can help you make a well-informed decision before using this form of financing.

How personal loans affect your credit

Depending on how you use a personal loan, it can have a positive or negative impact on your credit score. When you apply for a loan, a hard inquiry will be placed on your credit report, which can temporarily decrease your score by up to 10 points. It will remain on your credit report for up to two years but won’t impact your score after 12 months.

However, if you pay your loan back on time, it could improve your credit score as payment history counts for 35 percent of your credit score. Using a personal loan to consolidate high-interest debt will also lower your credit utilization ratio — which makes up 30 percent of your credit score — and could improve your credit in the long term.

Who a personal loan is best for

If you have good to excellent credit and need to refinance high-interest debt, using a personal loan may be wise. A personal loan off means the same payment each month and may be available at a lower interest rate than your current debt, which can save you hundreds of dollars or more.

A personal loan can also help pay for an important expense that you know you can’t save enough for, like home renovations or wedding costs. Because personal loan interest rates are typically lower than credit card rates, they’re useful if you know exactly how much you need and don’t want to carry a balance on your card.

When to use a credit card

Credit cards have rewards systems for frequent use, which makes them good for responsible everyday spending.

Paying off credit card balances at the end of the billing cycle is critical for maintaining your financial health. If you don’t pay your balance, and your card doesn’t have a 0 percent introductory rate period, interest will accrue. If you only make minimum payments, you could spend a long time repaying what you borrow.

So, you should only use your credit card for purchases you’re certain you can pay off in a reasonable amount of time.

A few ways you could use your credit card include:

• Making smaller everyday purchases.
• Paying for a well-planned vacation.
• Earning cash back or travel points.
• Taking advantage of a 0 percent interest opportunity.

On the other hand, a credit card may not be the best idea for paying off loans, making large purchases or covering expensive unexpected bills, such as medical costs.

Pros and cons of a credit card

When used responsibly, a credit card can be a great way to earn rewards, cash back and travel benefits. However, a credit card also has the potential to hurt your financial health.

How credit cards affect your credit

If you pay your credit card off on time each month, you will establish a history of on-time payments, which can help increase your credit score over time. And if you have long-established lines of credit cards that have been open for several years, you may get a boost on your credit score — length of credit history counts for 15 percent of your FICO score. This is particularly true if you have consistently maintained the accounts in good standing.

However, late payments of 30 or more days past due can damage your credit. Also, keeping a high balance on your card can lead to a high credit utilization ratio, which lowers your credit score. It’s typically a good idea to keep this ratio below 30 percent if possible.

The bottom line

Both credit cards and personal loans are useful financial tools that could also hurt your finances if used recklessly. Before you decide whether a personal loan or credit card is right for you, explore all of your options and compare rates and fees for each product by getting prequalified.

And keep in mind that using both is an option. For example, you may decide to get a personal loan for a one-time purchase and use a credit card for everyday expenses.

Frequently asked questions

• What impacts your credit score more: a personal loan or credit card?
  

  Both trigger a hard inquiry when you apply, which can result in a slight decrease in your score. That said, credit cards have a greater ongoing impact as your utilization ratio changes over time. If it’s low, your credit score could benefit. But if you drive your utilization rate above 30 percent, your credit score could drop.

• Will my credit score go up if I pay off credit cards with a loan?
  

  When you apply for a debt consolidation loan, your credit score takes a slight dip from the hard inquiry. However, once you receive the loan proceeds and pay off your credit card balances, your credit utilization rate — the amount of available credit in use — decreases. Your credit utilization rate makes up 30 percent of your credit score, so your credit score could improve, assuming you refrain from using the cards after paying them off.