The Credit Card Alternative You Might Have Overlooked

Whether you’re in a money emergency or need to finance a big-ticket purchase, it’s important to understand what type of debt you should take on. Ideally, you’ve got an emergency fund and savings account, so you don’t have to go into debt. But sometimes the furnace breaks, and you just don’t have the money saved up to replace it.

If this happens, you may turn to one of two other quick financing options: a personal loan or a credit card. So which is best? Each has its pros and cons, and which will work best for you depends on a variety of factors. Let’s look at what each option entails to help you decide.

Personal Loans & Credit Cards

Personal loans are typically unsecured installment loans. “Unsecured” means that if you default on the loan, the lender cannot seize any particular piece of property, like your car or home. Because the loan isn’t tied to collateral, it’ll likely have a higher interest rate. But because it’s an installment loan, it’ll have consistent, predictable monthly payments.

Credit cards are seen as a line of credit, which is also unsecured. As you’re likely familiar, credit cards allow you to charge purchases and then repay the lender what you owe. Credit cards come with a spending limit and interest is charged when you don’t pay off your balance in full each billing cycle.

Pros of Personal Loans

Less Negative Impact on Your Credit: Generally, installment loans have a lower potential to negatively affect your credit score. Because these loans typically don’t come with a credit limit, you won’t have to worry about your credit utilization (your debt-to-credit ratio) with personal loans. While taking on any new loans or line of credit will affect your credit score, you may get less of a ding from a personal loan.

Likely Lower Interest Rates: Because they’re installment loans, personal loans typically have a lower interest rate than credit cards. Interest rates are still high, though, compared with loans backed by collateral, like with a mortgage or car loan.

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Fixed Interest Rate: Most (though not all) personal loans come with a fixed interest rate, which makes them stable and predictable over time.

Fixed Monthly Payments: Because a personal loan is a one-time loan with a fixed interest rate, the monthly payments will stay the same throughout the loan’s term. Terms vary, but you’ll know what your minimum payment is throughout whatever the agreed upon term is.

Limits Your Debt Amount: A personal loan can be a good option if you want to borrow for only a specific expense. Because it won’t give you the ability to spend more, you won’t easily be able to go into more debt than you’d planned with a personal loan.

Cons of Personal Loans

Not a Revolving Option: Because personal loans aren’t revolving, you can’t decide later to use the loan to pay for an additional expense that pops up, like you might be able to do with a credit card.

Limited Term Options: Personal loans will come with a set term limit, usually less than 5 years. If you’re staring down a large expense, you may need to take on large monthly payments to meet the term limit.

Potentially Higher Payments: Because term limits can be short, you may pay more per month in minimum payments with a personal loan, even if the interest rate is lower. This isn’t always the case, as terms and conditions vary with different loans and credit cards. But you should be prepared for higher monthly payments with a short-term personal loan.

No Additional Perks: Typically, personal loans aren’t going to give you points or cash back like you may be able to get with a credit card.

Pros of Credit Cards

Potential for Introductory Rate: Credit cards with a 0% introductory annual percentage rate (APR) can be a good option for unforeseen expenses that you could pay off within 12 to 15 months. Get the purchase paid off in full before the introductory rate expires, and you won’t have to pay any interest at all.

Can Be Used More Than Once: Credit cards with a low introductory rate can be good to use as temporary emergency funds. You can charge to them more than once, pay off part of the balance, and then charge again if you need to.

May Come with Rewards: Most credit card issuers these days have some great credit card rewards options for consumers with average to great credit. You could net cash-back rewards for your spending, travel rewards or points when you use a credit card regularly or for one-time purchases.

Longer Term Options: Credit cards typically have a minimum payment requirement during each billing cycle instead of having you pay off the balance in a set number of months or years. Instead, you’ll likely face interest plus a certain percentage of principal each month that you don’t pay the balance in full. This means you can take a longer time to pay off a debt, if necessary, but it’s important to note that you will likely end up paying more than you borrowed.

Potentially Lower Monthly Payments: Because you don’t have to worry about a set term limit, credit card payments could be lower than personal loan payments for the same balance. This can vary, though, depending on relative interest rates and other terms.

Cons of Credit Cards

More Impact on Credit Score: Having a high balance on a credit card relative to the card’s credit limit is one of the worst things you can do for your credit score, as your debt usage accounts for 30% of your scores. So there’s definitely a potential for a large purchase financed by credit card to ding your credit score more than a personal loan would.

Possible Variable APR: Many credit cards have a stable APR, but that could still change. Plus, if you make a payment late, your APR may increase, which would increase both your minimum monthly payments and your total interest paid over time.

Variable Monthly Payments: For the most part, your credit card payments will depend on the card’s interest rate plus a percentage of the balance. So the higher your balance, the higher your minimum monthly payment. This varies by credit card, though, so be sure to look at the terms and conditions of your specific cards when you sign up.

Ability to Go Into More Debt: While the ability to go into more debt with a credit card can be a good thing, it can also be very bad if you’re not disciplined. It’s all too easy to start using a credit card for a specific purchase, only to find that you’ve spent up to your credit limit within a few months or weeks.

Which Is Best?

In general, if you qualify for a 0% APR introductory credit card offer and will pay off the total expense (or at least most of it) before the introductory period expires, a credit card may be a better financing option. Credit cards can also be a better option, generally, for small purchases that you’ll pay off within a month or two.

If you’re looking at longer-term financing for a big ticket item, a personal loan may be a better option. This is also true if you don’t qualify for a credit card with a low-to-no introductory APR, as interest rates on personal loans are likely to otherwise be lower than interest rates on credit cards.

Either way, it all depends on your preferences and your personal finances. Be sure to do your due diligence to find out what kinds of interest rates, rewards and other terms you’ll get from each option before you decide.

[Editor’s Note: It’s a good idea to review your credit before you apply for a credit card or personal loan, as it will likely affect what terms and conditions you qualify for. To find out where your credit currently stands, you can view two of your credit scores for free, updated every 14 days, on Credit.com.]