When you have to pay for something, you probably use cash, especially for everyday expenses. But where do you seek help for your next big purchase? With utility bills and debt in the way, you cannot always save money with a savings or long-term deposit account. If you are among many Australians who require a quick cash injection, you’re probably considering either taking out a personal loan or using your credit card.
Loans and credit cards have many similarities. You can use both of them to pay for your purchase, and you will be charged with interest and other fees. Of course, you will need to pay the money you borrowed. However, there are a few distinct differences between these two. Pay attention to the pros and cons of these choices to determine which can give you a manageable repayment option and which can lead you to an uncontrollable debt.
Key Differences Between a Credit Card & Personal Loan
A significant dissimilarity between a personal loan and credit card is their type of credit. With a credit card, you:
- Are working with revolving credit
- Can borrow money whenever you need it
- Have payments based on your outstanding balance at a certain period
Meanwhile, with a personal loan, you:
- Are dealing with an instalment loan
- Receive the money you need in a lump sum
- Repay the loan at an agreed schedule over a particular duration, such as six months or two years
The differences outlined above should help you decide easier because you will get to know the main characteristics of credit cards and personal loans.
When Should You Use a Credit Card?
Credit cards have become extremely useful to Australians over the past several decades. They are a critical part of the payments system in the country. With almost 16 million credit cards in circulation and more than 19 million accounts in 2018, the Reserve Bank of Australia confirms that nearly all adults have one credit card.
This downloadable spreadsheet from the RBA shows important figures concerning how Australians use their credit card each month. From January 2002 until January 2019, there were at least 10,000 new accounts. Since 2015, there were more than 80 institutions with 260+ credit card products.
About two-thirds of transactions in the country that do not involve cash are accounted for card use. In 2015 alone, credit card transactions averaged $24 billion monthly. Interestingly, the outstanding credit card debt during the same period amounted to $51.5 billion. Of which, $33.1 billion debt continued to accrue interest.
The problem is that most people do not understand what credit cards are for. They are best used for smaller expenses that you can pay off quickly. It’s recommended that you pay off the bill before the due date, so you essentially get a free short-term loan. Credit card companies do not charge interest if you have no month-to-month balance.
When you pay off your credit card dues early or on time, you can even use a rewards card to benefit from your account. The important thing here is discipline. You do not want to start spending more than you can pay off. Aside from the debt, there are interest payments you need to worry about, which do not make credit card debt worth the trouble.
So, where should you use credit cards instead? Here are some suggestions:
- Emergency expenses
- Rewards, such as frequent flyer points
- Paying off debt
- Doing a balance transfer
- A temporary solution to manage an income reduction
- Establishing a credit history
Should you use your credit card for a big purchase instead of a personal loan? Let us take a look at the benefits of using a credit card:
- You can make extra repayments any time of the month without any fees.
- You have the option to repay your debt with the minimum required amount.
- The more you use your credit card and pay on time, the better your credit score will be.
- You can use your credit card for almost any purchase that meets the spending limit.
- If you just got your credit card, you will often get an interest-free period, which means you do not have to pay any interest when making the minimum monthly repayment.
- Your credit card can be linked to a rewards program that gives cash backs, point schemes, and purchase protection.
On the flip side, credit cards come with a warning. Using the plastic is so easy that you could be tempted to spend more than you can afford. It’s the biggest disadvantage of all. You could fall into an even larger debt that becomes difficult to escape from since interest and penalty fees continue to accumulate if you could not repay your debt.
Another huge disadvantage is that you could be satisfied with paying off with the minimum payment. Unfortunately, you end up spending more on the interest, and you will discover you have been paying off the same balance for several years. That does not even include the additional charges you make on the card.
When Should You Use a Personal Loan?
Unlike credit cards, you do not have ongoing access to funds with a personal loan. You will receive the amount you borrowed and approved for, which will not refresh once a certain amount is repaid. You get a lump sum payment upfront, which you should repay in full over time through a scheduled arrangement. Once fully paid, you can retire the loan or even take out another.
About eight million Australians had applied for a personal loan at least once in their life. In November 2020, personal loan consumers rose 13.2%, perhaps due to the attractive rates. According to the RBA, the average variable interest rate is 14.41% while fixed loans averaged 12.42%.
If you already have a good credit score, you can enjoy a lower interest rate. A personal loan can either be secured or unsecured, which you can use to fund other purchases, including:
- Large, expensive purchases
- Consolidating credit card debt or any debt
- Repairing, upgrading, or renovating a home
- Providing extra funds for the income gap
- Establishing good credit
An unsecured loan is not backed by collateral while unsecured means you should provide security to get the loan. Collateral can be anything from your house to your car. If you fail to repay your loan, the lender has the right to take that specific asset. However, it offers better rates and easy approval for borrowers.
Should you take out a personal loan? Let’s take a look at its benefits of a personal loan:
- You can fund big purchases, such as buying a home or car.
- You get the money you need in full, no need to wait months to pay for your planned purchase.
- Most personal loans come with a lower interest rate, especially in comparison to credit cards.
- You can have a longer-term to pay for the whole amount you borrowed.
- You may be allowed to pay off the loan early.
- Repayments do not change every month (fixed-rate personal loans), allowing you to prepare for your next payment.
Taking the positives above, compare them to the disadvantages of a personal loan:
- The longer the term, the more interest you have to pay.
- Even though early repayments may be accepted for some lenders, fees may be involved.
- You will be charged a penalty or late fee if you do not pay on time.
- If you keep missing your payments, it will turn into a default, which will be recorded and affect your credit score.
If it is a secured personal loan, your house, car, or whatever asset you put up will be taken away from you.
Which is the Better Choice?
Both credit cards and personal loans require good payment habits. When it is time to pay off the loan or your credit card expenses, be prepared to provide the amount needed. With a credit card, you can opt to pay just the minimum required amount. On the other hand, you may be able to delay your payment for your personal loan but be prepared for extra charges.
More often than not, credit cards are recommended only for small, ongoing purchases. If you have a large purchase that you cannot pay off within a month, you are better off with a personal loan.
Financial decisions are among the most significant tasks you could face. That’s why you should only decide after carefully considering your situation, needs, and budget. While credit cards are a good way to enjoy some flexibility in your cash flow, you should be vigilant with your spending habits. To avoid any issues, always pay off the outstanding amount while it’s still interest-free.
Meanwhile, personal loans are useful if you have an upcoming big purchase that you can pay off for months or even years. They are an excellent option to control your existing debt. As long as you continue paying the loan on time, you can build a good credit score, which will help you get better offers in the future.