Every once in a while, you might need to spend a little more than usual—on new appliances, a major car repair, a cross-country move or maybe even a well-earned vacation.
Rather than dip into your savings, you search for an alternative way to pay.
Enter personal loans and credit cards. Which option is the best fit for your financial situation? If this question seems a little intimidating, we’re here to help make choosing a little bit easier.
How do personal loans work?
A personal loan is money lent to an individual, typically with a fixed interest rate, in which you get a specific lump sum of money up front, then pay it back in equal payments over an agreed-upon term.
Most personal loans are unsecured, meaning they don’t require you to secure the loan with your possessions. Personal loans are usually general-purpose loans that can be used to pay for a variety of expenses, such as a big vacation or a wedding. They can also be used to consolidate debt.
When you are applying for a personal loan, lenders may look at factors such as your credit history and income to assess your ability to repay the loan. With certain lenders, you can apply for a personal loan online, but you can also apply for a personal loan through a bank or credit union. For online loans, the approval process could take as few as 1 to 3 business days, but the exact timeframe for approval depends on the applicant.
Personal loan repayment is generally straightforward. For most personal loans, you make regular payments, usually every month, for a set term. Be sure to make your payments by the due date each month to avoid any late-payment penalties that your lender may charge.
The interest rate of your personal loan is often based on factors such as your creditworthiness and ability to pay. Lenders may also look at factors such as your income or expenses to determine your interest rate. For many personal loans, the interest rate is fixed—meaning the rate you qualify for won’t change over the life of the loan.
How do credit cards work?
A credit card functions as a line of credit that comes in the form of a little plastic card. You can make charges against this line of credit as needed, as long as you don’t exceed your credit limit, which is set by your issuer.
The most common way to apply for a credit card is online. You can also take advantage of card offers you receive in the mail, or you could simply call a credit card issuer to apply over the phone.
Getting approved for a credit card, however, is not guaranteed—whether or not you are approved and, subsequently, the interest rate that you qualify for both typically depend on your creditworthiness.
You are usually required to make a minimum payment, generally between 1 and 3% of the credit card balance each month. You can either pay off your entire credit card balance when your monthly payment is due, or you can choose to make partial payments of at least the minimum payment. A cautionary word: if you pay only the minimum, you’ll incur interest on the remainder of your balance. Therefore, choosing to pay more than the minimum could save you a great deal in interest charges in the long run.
Typically, when you don’t pay off your entire credit card balance, you accumulate interest on the balance that is carried over to the next billing cycle. But if you pay the full balance on time, in most cases, you won’t be charged any interest. Punctuality is very important with credit card payments: if you don’t make your payments on time, you could be charged late fees or your interest rate could change.
Your interest rate will largely depend on your creditworthiness.
Another thing to keep in mind is that credit cards usually have a variable interest rate, meaning your interest rate could change. For many cards, your rate is tied to the prime rate (the interest rate banks charge their most creditworthy customers to borrow money) and changes when the prime rate does.
Personal loans vs. credit cards: what’s best for you?
The first thing to keep in mind: there’s more to look at than just which one gives you the lowest interest rate. While that’s one important part, there are other factors that could make either a personal loan or a credit card the better solution for your needs.
For example, if you believe you’ll be able to pay off your purchases and/or debt fairly quickly, credit cards could be the better choice. This is true if you can pay off your balance in full each month, in which case you’ll likely pay no interest.
However, if you are not able to pay off your entire balance by your credit card due date and need more time to make payments, a personal loan could be the better alternative to a credit card because of its generally lower interest rate.
A great use for a personal loan is debt consolidation, especially if you currently have multiple high-interest credit cards. If you’re approved for a personal loan with a lower interest rate than your credit cards you could use the loan to pay off your high-interest credit card debts and then repay what you borrowed on the loan, paying less in interest overall.
Making a decision
We know there’s a lot to consider when determining which financing option is right for you.
Start by asking yourself: how much do I need to borrow, and how long do I need to repay it?
For short-term expenses you can to pay off quickly, a credit card may be more convenient for you. But what if you’re trying to finance the wedding of your dreams and you know you’ll need some time to pay back your debt?
For long-term expenses and big purchases, a personal loan could save you from paying more in interest and give you a set period to repay your debt.
This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs® but may not reflect the institutional opinions of Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.