Loans vs Credit Cards: Which Could be Right for You?

Sometimes, navigating the financial world can feel daunting. This can especially be true when faced with the question of a loan vs credit cards. Which is a better fit for your pocket? 

This guide is designed to help. We’ll shed light on the question of whether to take out a personal loan vs a credit card and look at situations where one might be more suitable than the other.

Understanding loans

A loan is a lump sum of money that you borrow and then repay in fixed amounts over time. Some key types of loans include:

• Personal loans: These are typically unsecured loans that can be used for various purposes, like home improvements.
• Car loans: These are tailored to vehicle purchases.
• Mortgages: Long-term, secured loans for buying a property.
• Student loans: These are loans specifically for students to help fund higher education.

Understanding credit cards

A credit card is sometimes known as a “revolving credit” facility. That means that instead of getting a single lump sum that you repay over time, you're approved for a certain credit limit to use over and over. 

This means you can use, repay, and then use those funds again. Features of credit cards include:

• Balance transfer: You may be offered the option of transferring a credit card balance from one card to another at a lower rate for a fixed period of time. Usually there is a fee charged for each balance transferred from another card, often around 2-4% of the amount you're transferring. 
  
  
• Rewards: Depending on which credit card you have, you can stand to earn points, air miles, or cash back. Please note, not all credit cards offer rewards. Check when applying.
  
  
• Minimum payments: Every month, you’ll need to pay a specified minimum amount back on your credit card balance. Paying more than the minimum can help to keep your credit usage low and reduce the amount of interest you pay. 
• Positive impact on your credit score: It’s possible to see an increase in your score as you get into the habit of paying your credit card bill on time, every month, while being late or missing a payment can have a negative effect on it. A direct debit instruction is one way to keep on top of this process.

Paying off the full balance as fast as you can afford to will help keep interest costs as low as possible.

Comparing interest rates

One of the major parts of the loan or credit card decision is interest rates. Typically, secured loans, like mortgages, have lower interest rates than credit cards. 

The interest rates on unsecured loans, like personal loans, may vary, depending on your unique situation and factors within your credit report. Interest rates applied to unsecured loans are often lower than the rates offered on credit cards.

It’s important to note that certain credit cards might lure you in with promotional 0% interest rates for a fixed term. However, the interest rates may then increase, sometimes dramatically, later on. Top tip - set yourself a 3 month reminder in your phone before the end of your promotional period to give you enough time to assess future options.

For this reason, always check the terms and conditions of any financial product you are considering. When wondering about a credit card vs loan, it’s important to keep a close eye on the situation under which you’ll be paying interest.

Credit card or loan, which is better? Pros and cons

Here’s a quick look at some of the pros and cons of loans versus credit cards. Weighing up the benefits and downsides can be an important way of deciding which option is right for you.

Credit Cards

Pros

• Convenience: Major credit cards are readily accepted at most stores and can also be used for online shopping.
  
  
• Rewards and benefits: Depending on the card you have, you may get cashback, points, or travel benefits.
  
  
• Short-term financing: Credit cards can be useful for short-term cash flow issues, particularly if you pay off the balance before interest accumulates. As a result, it’s not normally seen as a long term borrowing option.
  
  
• Builds credit history: Using your card responsibly and keeping up to date with payments can help improve your credit score.
• Flexibility in repayment: You could clear your balance every month or pay the minimum payment every month and everything in between. 

Cons

• High-interest rates: Allowing a big balance to accumulate on the card can mean hefty interest charges.
  
  
• Temptation to overspend: Swiping a card is easy. This can make it easy to quickly spend more than you set out to.
  
  
• Debt accumulation: If you don’t keep a close eye on your spending, you can find yourself burdened with a lot of debt you’ll struggle to repay.
  
  
• Fees: Some cards come with annual fees, late payment fees, as well as fees for taking out cash.  These can add to the cards’ costs in ways you might not budget for.
  
  
• Credit score impact: Making payments late or using a high proportion of your credit limit can harm your credit score.

Loans

Pros

• Fixed interest rates: Many loans, especially personal loans, offer fixed interest rates. This can be good news for monthly budgeting.
  
  
• Fixed payments: Another plus for the monthly budget. Fixed monthly payments help borrowers know exactly what they owe and need to repay each month.
  
  
• Large amounts: Loans can mean you have access to larger sums of money, in many cases more than a credit card would give access to.
  
  
• Builds credit history: On time and consistent repayments could help improve your credit score.
  
  
• Versatility: Loans are available for many different purposes. This includes things like buying a house, car, or funding education.

Cons

• Potential for overborrowing: Without proper planning, one might borrow more than is needed.
  
  
• Secured lending risk: Some loans, like homeowner loans, are secured against your property. Failure to repay the loan can mean losing your house!

• Fees: Some loans come with upfront charges, late payment fees, or prepayment penalties. This can increase their overall cost.
  
  
• Long-term commitment: Some loans, especially mortgages, can have a length of agreement that lasts for decades. That means they’re a long-term financial commitment and will require diligent repayment for many years.

Assessing your financial situation

When choosing between a credit card or loan, an honest look at your finances is also important. Here are some factors to think about when considering which one might be best for you.

• Income: Having a regular, consistent income aligns well with predictable loan repayments. For those with fluctuating incomes, the adaptability of credit cards can be a plus.
  
  
• Credit score: A good credit score can help you secure favourable interest rates for both credit card and loan applications.
  
  
• Financial goals: Are you looking to make a big, one-time purchase or many small ones over time? A loan may be more suited to the former, while a credit card may be better suited to the latter.
• Short vs long term requirement: Assess whether the expense is short or long term. This may help in deciding whether a credit card (a short term option) or loan (medium-long term) is best for you.

Emergency and unforeseen expenses

In addition to the above considerations, it’s also wise to consider unexpected events. After all, life is unpredictable. In other words, the loan vs credit card choice can also hinge on the need for emergency funds. 

Credit cards can provide immediate access to funds in case of unforeseen expenses, making them invaluable in emergencies. However, the caveat is the typically higher interest rate, which can mean debt accumulates quickly if the balance isn't paid off promptly.

On the other hand, an emergency loan like a payday loan will likely offer you a very high interest rate. 

It's always a good idea to have an emergency fund or other plan in place, so you're not caught off guard.

Making the Right Choice for you

When it comes to the question of whether credit cards or loans are better, there isn’t a one-answer-fits-all answer. Rather, take some time to reflect on these to decide which is best for you. For some using both a credit card and loan simultaneously and responsibly could be an option.

• Duration: Loans often favour long-term commitments, whereas credit cards cater to short-term or emergency needs.
  
  
• Amount: For significant amounts, loans are often more viable, whereas credit cards work best for smaller, individual expenses.
  
  
• Control: You are in control and whether you opt for a loan or a credit card (or none at all), it’s important to look at your options before making a decision that suits you.

Looking at factors like these will help you work out the answer to whether a loan is better than a credit card for your specific wants and needs.

FAQs

Q: Is it better to have a credit card or a loan? 

A: The answer here is dependent on your specific financial goals, needs and situation. For one-off large expenses, a loan may be a better choice. For flexibility or smaller purchases over time, credit cards could be the right choice.

Q: Do loans build credit faster than credit cards? 

A: Both can build credit. Consistent repayments, whether for a loan or credit card, can help to improve your score.

Q: Is having a credit card the same as having personal loans? 

A: No. While both provide funds, credit cards are revolving. That means that once you pay back outstanding funds, they’re available for use again. 

Personal loans give a lump sum to be repaid in instalments. Once you make a repayment , the funds are no longer available.

Q: Should I get a credit card before a loan?

A: Depending on your circumstances, it can help. 

Using a credit card responsibly can enhance your credit score, potentially securing you better loan terms later. However, having a high credit utilisation ratio, or failing to make timely payments can hurt your credit score.