If you’re facing an emergency expense and your savings have run dry, your next step is to evaluate your potential options. Two of those options that people often jump to is to put the expense on their credit card, or apply for a personal loan to help them cover the cost of the emergency. But which of these potential avenues makes the most sense?
The truth is, deciding between a personal loan or credit card is largely going to come down to your specific needs, your preferences, and your financial situation. So, this means you’ll have to make sure you have a clear sense of where you stand and what you’re looking for. Next, you’re going to have to have a good understanding of the options that are potentially on the table and what each one is suited for.
So, to help give you a hand, we’re going to go over some of the different types of personal loans and credit cards out there, how they work, and when you might consider applying for them.
What are Personal Loans?
There are plenty of different types of personal loans out there, many of which have their own specific uses, but generally speaking, a personal loan is money that you borrow for some sort of personal expense. You can apply for them through banks, online lenders, credit unions, and storefront lenders.
Things like the cost and term of the loan are going to vary based on things like your credit score, the financial institution you’re working with, the loan you’re applying for, and more. Usually, your interest rate will be fixed, depending on the type of loan. The process of repayment is also going to vary.
3 Different Types of Personal Loans
1. Lines of Credit
Lines of credit are a type of revolving credit, meaning you can borrow funds on a continuous basis. You’ll have a credit limit to draw funds from, which may be determined by your credit score and certain other aspects of your financial profile. A credit card is another example of a revolving credit account.
When it comes to paying back the money you’ve used on your line of credit, you’ll need to pay back what you owe by the end of your billing cycle, or at least make your minimum payment. This allows you to keep your account in good standing. The interest and/or fees you’ll be charged will be based on the amount of money you’ve used, not the total limit of your line of credit.
2. Installment Loans
There are all sorts of loans that can fall under the umbrella of installment loans. This can include things like, student loans, auto loans, and mortgages. In general terms, an installment loan is a type of loan which you’ll need to repay over a series of pre-determined and equal payments. The money you receive will be given to you in a lump sum.
3. Title Loans
With a title loan, you’ll need to secure it with some type of collateral. For example, in some cases, the collateral you’ll need to put up is your car. The important thing to note here is that with a secured loan, if you start to miss your payments, the lender may seize the collateral you’ve put up in lieu of payment. So, because of this, there’s a substantial element of risk with these types of loans. You should always consider them to be a last resort for emergencies, and you should never apply for one if you’re not sure you’re going to be able to make your payments.
When Can I Consider Applying for a Personal Loan?
An important aspect of responsible borrowing is knowing what certain loans are intended to be used for, and when you may want to consider applying for one. Here are some situations in which a personal loan may be useful.
1. You Need Money in the Form of a Lump Sum
If you’re facing a relatively large unexpected expense and you need a decent amount of money in one go, something like a personal installment loan may be useful. For example, let’s say your roof is leaking and it’s going to cost you $2,500 to fix it. A personal loan may be able to provide you with the lump sum you need to take care of it if your savings are short.
In this situation, one of the key points to note is that you’ll know exactly how much you need. Because of this, you won’t necessarily need the flexibility provided by a revolving credit account. In general, if it’s a one-time expense with a fixed cost, a personal loan may be a viable option.
2. You Prefer Structured Repayment Amounts
Other than lines of credit, most personal loans have a fixed term, amount, and payment schedule. This means that you’ll know how much you’re going to have to pay that month well ahead of time. So, as long as you know you’ll be able to incorporate your payments into your budget, and if you prefer the structure of something like an installment loan, it may be one option for you.
3. You’re Trying to Make a Large Purchase
When you need to make a large purchase of some sort, a personal loan can be an option because it can give you the opportunity to spread your payments out over a longer period of time. While you may have a big enough credit limit to put a large purchase on your credit card, it may be difficult to pay it all back by the end of your billing cycle. While you still may be able to make your minimum payment, you’ll still be accruing interest.
What are Credit Cards?
Just like a line of credit, credit cards give you access to a credit limit that you can borrow money from. They’re generally used for everyday expenses, although they can be used for larger purchases in some cases.
With a credit card, you’ll need to make at least a minimum payment every billing cycle to keep your account in good standing. The size of your minimum payment is going to change month to month depending on how much credit you’ve used. That being said, you should typically try to pay back as much as you can afford to.
On top of this, you’ll want to make sure you’re never spending more money on your credit card than you can afford to repay. The bigger the unpaid balance that remains on your account at the end of your billing cycle, the more debt you’ll accrue.
3 Different Types of Credit Cards
While most credit cards have the same basic structure, there are certain features that can make some cards more suitable for people in certain situations, while other cards may be better for people in others. Here are three common types of credit cards that you may come across.
1. Beginner Credit Cards
If you’re at or near the beginning of your credit journey, there are beginner credit cards meant to help people like you start building your credit history. When you make purchases on your credit card, your activity will be reported to one of the three major credit bureaus – Equifax, Experian, and TransUnion. This will help contribute to your credit history. Because you’re early in your credit journey, your credit limit on a beginner card is not likely to be particularly high.
2. Credit Cards with Low Interest
Another type of card that you might come across are ones that advertise 0% APR. However, this feature likely won’t last forever, as it’s usually just an introductory period lasting anywhere from a few months to a couple of years.
Over this phase, you typically won’t be charged interest on certain types of transactions, which can include things like balance transfers and qualifying purchases. Just keep in mind that once this period ends, standard interest rates will likely start to apply.
3. Credit Cards for Students
These cards are meant to provide access to credit for post-secondary students. You’ll typically need to be at least 18 years of age and will need to be at least a part-time college student. Like beginner cards, they’re meant to help students break into the world of credit cards and these may even come with low interest rates and/or fees.
When Can I Consider Using a Credit Card?
So, why would you choose to use a credit card over a personal loan? Let’s take a look at a few things to consider.
1. Convenience is your Main Priority
If you’re looking for a financial tool to help you make everyday purchases at nearly every type of establishment, then a credit card can be a good choice. It generally makes no difference whether you do most of your shopping online or in person, as almost all retailers in both spaces accept credit cards.
2. You Want Something you can Use Everyday and Long Term
Because credit cards are a type of revolving credit, you can borrow money on a revolving basis. This means that as long as you make sure your account remains in good standing, you can use your credit card for as long as you keep your account open.
With certain types of personal loans, you receive your money in a lump sum, and then need to repay it by a fixed date, or a series of scheduled payments. This can be fine for short-term expenses, but if you’re looking for something long term, it may not the most efficient system. You would need to apply for a new loan every time you needed more funds.
3. You’re Comfortable Managing your Spending
If you carry a debt on your credit card from month to month, things tend to get expensive. In order to avoid building up more and more debt, you’ll need to make sure you pay off your entire balance every month. If you’re someone who can comfortably manage your spending and make sure you’re able to pay off your entire balance each billing cycle, then a credit card can be a useful spending tool for you.
Consider all your Borrowing Options Carefully
Both personal loans and credit cards can give you access to money that you’ll then need to repay at some point in time, but there are significant differences between how these products operate. It’s important to understand your needs, have a clear idea of what financial products are out there and how they work, and try to find something that aligns with your situation. Overall, make sure to exercise patience and don’t make any rash decisions when it comes to your finances!
Posted in: Personal Loans