When you need a loan, you generally have two alternatives: personal loans or credit cards. Each has its own advantages and disadvantages, and the best choice depends on your financial circumstances and goals.
Credit card loans are typically easier to access; however, they are usually charged a higher interest rate. Personal loans, on the other hand, may have lower interest rates, but can be difficult to qualify for. Let’s read to weigh the two alternatives and then decide which one fits best.
Overview of Personal Loans
A personal loan is a fixed amount of money borrowed from a lender, which is repaid in regular installments over a set period, usually ranging from one to seven years.
Each repayment consists of both the principal and interest. Personal loans are often used as alternatives to credit cards for larger expenses. There are broadly two types of personal loans: secured loans, which require collateral, and unsecured loans, which do not.
Set Borrowing Amount
When you take out a personal loan, you’re approved to borrow a certain amount of money. You can’t spend beyond that limit, unlike a credit card, which offers a revolving line of credit.
Example
Let’s say that you are offered a definite cost for a bathroom renovation that you have to pay in a lump sum. A personal loan will be good since you know the maximum amount of money that you will require, and it is higher than your credit card limit.
Repayment and Interest Rates
Personal loans typically have lower interest rates compared to credit cards. You will need to decide whether you want a loan with a variable or fixed interest rate.
Fees
A personal loan typically has an establishment fee, which is a one-time charge paid when the loan is initiated to cover the lender’s costs of processing the application. Borrowers may also pay a small monthly fee as part of the loan maintenance.
Overview of Credit Cards
Credit cards are ideal for daily expenses. Rather than receiving a lump sum of money, credit cards offer revolving credit, which means continuous access to cash in the form of a credit card that you can use at any given time. As you make purchases with the card, your available credit goes down. And as you make repayments, it increases again.
With a credit card, you are charged interest on only what you use. Your credit card has a grace period (most credit cards have a grace period on new purchases, but not on cash advances), and you can save on interest charges as long as you can pay your entire balance in time before the due date.
Manage Your Credit Limit
The minimum credit card limit often begins as low as $1,000. With credit cards, you can spend as much as you have in your wallet, unlike a personal loan, where you borrow a specified amount, and that is all you can spend.
Repayment and Interest Rates
Credit cards generally carry higher interest rates than personal loans. You must make at least the minimum payment by the specified due date each month, as indicated on your credit card statement.
Fees
Besides helping you cover short-term cash flow or monthly expenses, credit cards have a number of other useful features:
- Convenience: Shop in-store and via the internet without cash. The credit cards can provide access to cash fast and securely anywhere you need it.
- Rewards and Perks: Numerous credit cards have reward schemes that allow you to receive points for each dollar spent. Such points are redeemable in flights, stays, gift cards, and a variety of other gifts.
Comparing Costs and Flexibility
When deciding between personal loans and credit cards, understanding their differences in costs and flexibility can help you make an informed choice.
Costs (Personal Loans)
- They are more affordable than credit cards and are usually charged a lower interest rate on larger or longer borrowing.
- Interest rates may be variable or fixed. A fixed rate offers greater certainty in repayment planning.
- Be sure to factor in establishment fees (one-time) and, in some cases, monthly maintenance fees, all of which will increase the overall cost of borrowing.
Costs (Credit Cards)
- Have less competitive interest rates, particularly on the balances held after the grace period, which makes it expensive not to pay up the entire balance monthly.
- Interest is only computed on the amount you use, and not on the credit limit.
- Cash advances are charged with interest instantly, and in most cases, there are other charges.
- May charge an annual fee or other service fee, depending on the type of card.
Flexibility (Personal Loans)
- Give a fixed amount in a lump sum so that you do not get a chance to borrow more without having a new loan.
- Repayments are scheduled and fixed, which may assist in budgeting and financial planning.
- Best suited to planned but once-in-a-lifetime costs such as home renovations or debt consolidation.
Flexibility (Credit Cards)
- Provide the revolving credit where one can borrow repeatedly to his/her credit limit without a reapplication, hence making it very flexible in the case of continuous or unforeseen expenses.
- Minimum monthly payments will provide more flexibility in terms of short-term cash flow, but will result in more overall interest when balances are not paid in their entirety.
- Perks and reward programs do not add value to only borrowing.
When to Use Each
A personal loan is ideal when you need a larger amount of money for planned expenses such as = home renovations, debt consolidation, or the purchase of major items. Personal loans are the best option if you prefer fixed monthly payments, lower interest rates, and a clear repayment timeline. They are best suited for borrowers who want budgeting certainty and are comfortable applying for a loan directly with a lender.
Managing debt and budgeting wisely are key skills for improving your personal finances in Canada. Use a credit card when you need quick and flexible access to money to handle daily or emergent needs, like grocery shopping, minor home maintenance, or traveling.
Credit cards help manage short-term cash flow and provide revolving credit without the need to reapply. They’re most beneficial if you can pay off your balance before the grace period ends. This avoids high-interest charges while enjoying rewards and perks.
Discover Canada’s top lenders at Smarter Loans and borrow with confidence.
Written by:
Amy Orr is a professional writer and editor with over 10 years of experience in the Canadian, U.S. and U.K. financial markets. She has written for numerous publications on topics as diverse as economic literacy, corporate finance, and technical analysis of numerical data. Prior to transitioning to full-time writing, she worked in the hedge fund sector. Her academic background is astrophysics, and she has a Masters in Finance from the University of Edinburgh Business School.
