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Personal loan vs. credit card: How to decide which is right for you

Yahoo Personal Finance· Getty Images
Robin Hartill, CFP®
Updated 14 min read

If you need to borrow money, two options are a personal loan or a credit card. Both require you to pay back the principal amount you borrow with interest, but there are a lot of differences to be aware of.

Here's how a personal loan compares to credit cards, the pros and cons of each, and which one to choose when you’re facing a big expense.

A personal loan and a credit card are two different types of credit. Here’s what they have in common:

  • Both require you to make monthly payments.

  • You’ll repay the principal amount you borrow, plus interest.

  • Most personal loans and credit cards are unsecured credit, meaning they aren’t backed by collateral — though there are some secured credit cards and personal loans.

  • Both typically require a credit check when you apply. Though it’s possible to get a credit card or loan with bad credit, applicants with good to excellent credit get the best terms.


Now for the key differences between personal loans and credit cards.

A personal loan gives you a lump sum of cash to borrow, whereas credit cards are a type of revolving credit. You borrow a predetermined amount with a personal loan and pay interest on the entire amount over a set period.

With revolving credit, like a credit card or home equity line of credit (HELOC), you get a line of credit that you can charge up, then pay off. You can choose to pay off the balance in full each month, or you can make the minimum monthly payment.

Personal loans charge a fixed interest rate, which means your interest rate won’t change during the life of the loan. Credit cards have a variable interest rate that can go up and down, depending on factors like market rates and whether you pay your bill on time.

For both personal loans and credit cards, the annual cost of borrowing money is expressed as the annual percentage rate (APR). Personal loans typically have lower APRs than credit cards, particularly for borrowers with good to excellent credit.

With credit cards, your monthly payment depends on how much you’ve charged. Minimum payments vary by credit card issuer, but they’re often about 2% to 5% of the outstanding balance. If you only have a small balance — say $35 or $40 — the entire balance may be due in full. You can choose to pay more than the minimum amount each month, which saves you money on interest and speeds up your repayment schedule.

Personal loans have a fixed monthly payment and payment schedule. You know what your monthly payments will be when you take out the loan. Personal loans are sometimes called installment loans because you pay them back in monthly installments.

Personal loans and credit cards charge different types of fees. It’s essential to read the terms of any credit card or loan contract before you sign.

Common personal loan fees:

  • Origination fee: Some (but not all) lenders charge an upfront fee called an origination fee, which can run as high as 8%. If your lender charged a 3% origination fee on a $10,000 loan, you’d need to borrow slightly more than $10,300 to actually receive $10,000.

  • Prepayment penalty: Some lenders charge a flat fee or a certain amount of interest if you pay off an installment loan early.

  • Late fees: Expect to pay a late fee if you don’t make your payment by the due date. Some lenders charge a percentage of your balance, while others charge a fixed amount, like $25 or $30.

Common credit card fees:

  • Annual fees: Credit card annual fees can range from less than $50 to more than $500, though not all credit cards have an annual fee. Some of the best rewards credit cards charge a hefty annual fee, which is sometimes worth paying if you’ll spend enough to earn substantial rewards.

  • Late fees: As with personal loans, you’ll usually incur late fees if you don’t make on-time payments. You may also be charged a penalty APR, which means you’ll pay a higher interest rate.

  • Foreign transaction fees: Some cards charge as much as 3% on purchases you make outside of the U.S.

  • Balance transfer fee: Some people transfer credit card balances to a different credit card, often to take advantage of a lower APR. But with such balance transfer cards, you can expect to pay a balance transfer fee of 3% to 5% of the amount you transferred to the new card issuer.

Some credit cards offer rewards, such as cash back, airline miles, or points that you can redeem for statement credits, gift cards, or to pay for purchases on certain websites. Unlike credit cards, personal loans don’t have rewards programs.

Suppose you need access to $10,000 to cover emergencies. You’re considering a 24-month personal loan with a 12% APR vs. a credit card with a 20% APR.

If you choose the personal loan: Your monthly payments will be around $470 and will remain the same for the full 24 months of the loan. Now, say you only need to spend $2,000 of that money, while you keep the other $8,000 in cash. You’ll still pay interest on the entire $10,000 you borrowed, or a total of $1,297 over 24 months.

If you choose the credit card: Say you immediately charge $10,000 to a credit card at 20% APR. If your minimum monthly payments were $200 and you paid only the minimum, it would take you 109 months (that’s nine years and one month) to pay off the entire balance. You’d pay $11,680 in interest costs alone.

If you were determined to pay off the card in 24 months, your monthly payments would be $508, assuming your APR doesn’t change. But you’d pay significantly less interest, totaling just $2,214 over 24 months.

But what if you took out a $10,000 line of credit and only charged $2,000 due to a one-time emergency expense, just like in the personal loan example? You could pay off the entire balance making $101 monthly payments, and you’d only pay $443 interest over 24 months. Even though the credit card charged you a much higher APR, you still saved money with the credit card because you only paid interest on the amount you needed.

Most financial institutions review your credit history as part of the application process for a credit card or loan. This results in a hard inquiry on your credit report, which may cause your credit score to drop by a few points in the short term.

If you make on-time payments, both personal loans and credit cards will help you build credit and improve your credit score over time. If you make late payments or miss them altogether, you’ll damage your credit score. That’s because your lender will report your payments to the three credit bureaus. Payment history accounts for 35% of your credit score – more than any other credit factor.

But having credit card debt could actually be worse for your credit score than having a personal loan. That’s because 30% of your credit score is determined by your credit utilization ratio, which is the percentage of open revolving credit you’re using. The lower your credit utilization ratio, the better. A common recommendation is to keep this number at 30% or lower.

Because only revolving credit counts toward your credit utilization ratio, an outstanding loan balance doesn’t tend to hurt your credit score. That’s one reason many people use a personal loan for debt consolidation. By rolling your credit card balances into a loan, you can instantly lower your credit utilization while usually saving money on interest.

Keep in mind, though, that your credit score is only one measure of creditworthiness that lenders consider when you’re seeking financing. Having high loan balances will still increase your debt-to-income ratio, which could hurt your odds of approval if you’re applying for a mortgage or another type of credit.

Sometimes you need a loan or credit card for an emergency, but which should you choose?

If you have a credit limit high enough to cover the expense and you’re confident you can pay it off quickly, using a credit card may be easiest. You won’t have to apply at a bank or credit union to borrow money and wait for funding. A credit card is often best for a one-time emergency expense that’s relatively small, like a car repair or an urgent care bill.

A personal loan is likely a better option for a larger emergency expense, like a major home repair or a big medical bill. You can usually lock in a lower rate, and because the payments are fixed, you’ll know how much to budget for each month. Keep in mind that many personal loans take one to five business days to fund, though some lenders offer same-day funding. It’s important to keep that timeframe in mind if you need money right away.

Two points of caution:

  • Sometimes, you need cash in an emergency, in which case a credit card won’t suffice. One option is to take out a cash advance, which is a way to borrow cash against your line of credit. But cash advance interest rates are usually much higher than credit card and personal loan rates. Unlike credit card purchases, they often start to accrue interest right away. Be sure to see if you qualify for a lower-interest personal loan first before you take a cash advance.

  • Payday loans are a type of short-term personal loan that doesn’t require a credit check, but the interest rates are exorbitant. Many charge 400% APR or higher, though some states have capped interest rates. A payday loan is usually the most expensive way to borrow money, often trapping borrowers in a debt cycle.

Here are some pros and cons of choosing a personal loan over a credit card:

Pros

  • APRs are typically lower. Though APRs vary by lender, the best personal loans usually have lower interest rates than credit cards, particularly if you have good credit. Because the APRs tend to be lower than credit card rates, many people use personal loans as debt consolidation loans.

  • Payments are fixed. Because the payments on an installment loan don’t change from month to month, you know the loan amount and repayment terms upfront and can budget for them.

  • Higher limits than credit cards. Depending on the lender and your creditworthiness, personal loan limits can be as high as $50,000 to $100,000. That’s significantly higher than the limits on most credit cards.

  • You’re less likely to become dependent on borrowed money. Because you’re borrowing a fixed amount of money that you’ll pay back on a schedule, a personal loan is less likely to tempt you to spend money that you can’t afford.

  • Less impact on your credit score. Because personal loans don’t count toward your credit utilization ratio, personal loan debt hurts your credit score less than credit card debt.

Cons

  • You could pay interest on money you don’t need. You’ll still owe interest on the entire amount you borrow, even if you only wind up using a fraction of that money.

  • You’ll need to go through the loan application process again to borrow more. With a credit card, you can charge up your line of credit as needed and can easily ask for a limit increase. But with a personal loan, you’ll probably need to apply for a new loan if you need to borrow more.

  • No rewards. While many credit cards have generous rewards programs, you won’t earn rewards on money you borrow through a personal loan.

Using a credit card also has several benefits, as well as a few drawbacks you should know about.

Pros

  • You can limit borrowing to the amount you need. Since a credit card is a form of revolving credit, you can make charges against your line of credit as needed, then pay it off. By contrast, with a personal loan, you have to decide how much you want to borrow ahead of time. If you wind up borrowing more than you need, you’ll pay unnecessary interest.

  • Interest may be avoidable. If you pay off your credit card balance in full each month, you can avoid paying interest. Some credit cards even have a temporary 0% interest introductory period of anywhere from 12 to 21 months, though to qualify, you’ll typically need good credit.

  • You can earn rewards on purchases. Many credit cards offer rewards on purchases, such as cash back, points and airline miles. However, if you accrue interest because you carry a balance, you’ll typically negate the value of your credit card rewards.

  • More convenient than a personal loan. A credit card allows you easy access to borrowed funds since you have a line of credit that remains open indefinitely. You don’t need to fill out a new application any time you need money, which makes a credit card handy for everyday purchases or in an emergency. You can also request a credit limit increase by calling your credit card company.

Cons

  • High interest rates. Credit cards tend to have higher interest rates than personal loans. Store credit cards have particularly high interest rates, with many charging 30% APR or higher.

  • Temptation to overspend. You may be tempted to make unnecessary or large purchases with a credit card, particularly if you have a high credit limit. Because the minimum payment is usually a small fraction of the total balance, you may not notice how much debt you’re accruing. It’s easy to live beyond your means when you rely on a credit card for everyday expenses.

  • High impact on your credit score. Because your credit utilization ratio is based on the percentage of revolving credit you’re using, credit card debt will hurt your credit score more than a personal loan.

Personal loans and credit cards are both ready options when you need to borrow money. But as with most decisions about personal finance, there’s no one-size-fits-all solution.

In general, a personal loan is best for:

  • Consolidating high-interest debt

  • Large projects or expenses such as home improvements

  • Emergencies where you need cash

A credit card is often better for:

  • Everyday spending

  • A major purchase if you qualify for a temporary 0% APR

  • Smaller emergency expenses

Whether you choose a personal loan or a credit card, responsible borrowing and spending is key. Avoid borrowing more than you need through a personal loan. Doing so means you’ll spend more on interest. Likewise, avoid charging up a credit card by buying things you don’t need. If you use your credit card for daily expenses, try to pay off the balance in full each month. You’ll avoid excessive interest charges, and you’ll be less tempted to live beyond your means.

Is credit card debt or personal loan debt worse?

Credit card debt is generally worse for your credit score than personal loan debt, and it typically carries a higher interest rate. However, there are some situations in personal finance where it makes sense to use a credit card, like if you’re taking advantage of a 0% APR for a major purchase.

Is it better to pay off a credit card or personal loan first?

It’s generally best to pay off a credit card first. The APRs are usually higher, so you’ll save money on interest, plus you’ll lower your credit utilization ratio, which helps your credit score.

When should you use a credit card instead of a loan?

A credit card is best for daily spending, as well as purchases you can pay off in the short term. If you qualify for a temporary 0% interest period, using a credit card for a major purchase makes sense, but only if you can pay it off before the interest-free window ends.

Editorial Disclosure: The information in this article has not been reviewed or approved by any advertiser. The details on financial products, including card rates and fees, are accurate as of the publish date. All products or services are presented without warranty. Check the bank’s website for the most current information. This site doesn't include all currently available offers.