All of us at some point in the modern world need credit, but it’s far from easy to decide the form in which to obtain it. Perhaps the two most common choices are credit cards and loans, but even then it can be a bit daunting. We take a closer look to help you make the decision, and it’s not always down to the best interest rate.
Unsecured Personal Loan
Since we don’t all have millions in our coffers, a generous rich great aunt, and taking out equity from our home just seems counterintuitive after plugging away at a mortgage for so long – a personal loan is always worth considering when looking toward that particularly large but manageable purchase. However because you do not have to pledge any collateral, interest rates on personal loans are some of the highest in the industry. This is not necessarily comparatively bad, after all a mortgage might have a better rate but it’s still going on hundreds of thousands of brick and mortar. Your personal loan may be for just a few hundred dollars. But it’s still worth keeping in mind when comparing to other products.
Personal loans are for a set principal amount, over a set period of time (months to years), and typically with a fixed interest rate. You’ll know exactly how much you will be paying each month. For the boxed minded, there’s certainly nothing to get confused about. If you know what you want to buy and have worked out your sums, it may be the perfect option for you.
The majority of lenders aim to lend more than $1,000 to make it worth their while. If you have a good credit score and a stable income, you can even go as high as $100,000. After this you’ll need to offer collateral.
The one catch to some personal loan lenders is that they require an origination fee that can be as high as 5% of the principal.
Credit cards can carry even higher rates than personal loans, but the way they function can also be much more convenient and save you money in the long run. Firstly the interest on a credit card balance is not fixed over a set period of time like a loan. You don’t spend £3,000 on a card and then get stuck with a 12% rate fixed over 12 monthly instalments. Knock off £500 the next day and interest only continues to be applied to £2,500.
Secondly and perhaps the key benefit of the trusty plastic is that you don’t actually pay any interest at all for the first 30 days after using it, whereas with a loan you are paying interest from day one. Of course you have to pay the credit card company back pronto, but until that point it’s as good and cheap as cold hard cash. That makes credit cards ideal at least for smaller day to day purchases that you can cover within your monthly budget. It’s only after those 30 days (perhaps when you splashed out on that holiday) that the interest hits (and hard depending on the rate).
Another benefit of credit cards that might give them the edge in your mind is their versatility. You don’t have to carry psychical money around with you; all transactions are protected by the card issuer and can be easily disputed and reversed, and then there’s online shopping. Who doesn’t love online shopping? The trade off is the interest, but as mentioned above – you don’t have to give them that if you’re smart.
The debate then really becomes one of personal circumstance. If you can realistically afford to put everything you want on a card for 30 days and then pay it off to avoid interest altogether, then you should choose a credit card over a personal loan.
If you’re in luck you might also find some introductory rates and interest free purchase periods that really do rival loans for larger purchases over the long term as well.
Personal loans however are always better for larger purchases, especially if it will take you more than a year to pay everything back and you don’t trust yourself with a credit card, which is ever so tempting to overindulge with.
A rule of thumb is that if you want to spend over $5,000 (which is higher than the average person’s credit limit on their card) or you want to spend over $1,000 and this will take you more than 15 months to do so comfortably, a personal loan is the much better choice. Of course your own financial situation may dictate otherwise.