If you need to borrow money, you may be considering applying for a credit card or personal loan. Both can help you to fund purchases such as a new car or home improvements, or they can help you to consolidate existing debts. However, it is important to understand the differences between them and choose the option that is best for you.
Credit card vs Personal loan
Credit cards allow you to borrow up to a certain limit, as set by your credit card provider. This limit could be a few hundred or a few thousand pounds and is often determined by your credit rating. The higher your credit score, the higher your credit limit is likely to be. Your income may also play a part.
Your credit card provider will have a set minimum payment that you must make each month, but this is often low so it’s best to pay more if possible. As you repay the money, you can also borrow again. Some credit cards offer interest-free deals for several months, but others charge interest unless you pay off the full balance each month.
Personal loans, on the other hand, typically allow you to borrow a larger sum of money as a lump sum. You then repay a fixed amount each month over a set ‘term’ - this is typically between one and five years, although some providers let you borrow over seven years or longer.
The amount of interest you are charged will depend on how much you borrow and the length of the term. Rates can be more expensive for smaller borrowing amounts, say under £5,000.
Pros and cons of credit cards
- You may be able to borrow interest-free - 0% purchase and 0% balance transfer cards allow you to avoid paying interest for a number of months
- Payments are flexible so you can choose how much to repay each month (so long as it is at least the minimum monthly repayment)
- You can pay off the amount in full without penalty
- Credit card purchases are protected by Section 75 of the Consumer Credit Act. If you buy something costing between £100 and £30,000 with a credit card (even if you put down a deposit), your card provider is jointly liable with the retailer if something goes wrong
- Minimum monthly repayments are often low so it is best to pay more than that if you can
- Interest rates can be high, particularly if you have a poor credit rating
- There is no deadline by which you need to have paid off your balance, so it can take a long time to clear. If your credit card comes with a 0% deal and you don’t clear your balance before it ends, you will start paying interest
- Credit limits can vary and may not be high enough for your requirements
Pros and cons of personal loans
- You can usually borrow more with a personal loan than with a credit card
- You can choose how long you need to repay the amount borrowed
- You may pay less in interest than you would with a credit card
- Your loan repayments will remain the same each month
- Some providers let you make extra monthly payments with no charge
- If you want to borrow a smaller amount, say £3,000, interest rates can be higher
- If you want to pay off your loan early, you may have to pay a penalty charge. This can be equivalent to one to two months’ interest
- Monthly payments are not flexible
Interest rates on credit cards vs personal loans
Below, we have put together two tables to give you an idea of how much interest you could be charged on a credit card or personal loan, and how much you would repay in total.
The first table shows three of the top credit card deals for purchases, each with a different interest rate. The total amount repayable will depend on how much you borrow and the amount you pay back each month. We have used the example of borrowing £3,000 and paying back £120 a month.
Example table showing how much interest you could pay on a credit card
|Provider||Amount borrowed||Interest rate||Minimum repayment||Monthly payment - decided by customer||Total amount repayable||Total interest paid||Time taken to pay off|
|Sainsbury’s Bank||£3,000||0% for up to 27 months, then 20.9% APR*||Greater of £5 or 2.25% of balance||£120||£3,000||£0||25 months|
|M&S Bank||£3,000||0% for 20 months, then 19.9% APR||Greater of £5 or 2.25% of balance||£120||£3,029||£29||26 months|
|Lloyds Bank||£3,000||9.9% APR*||Greater of £5 or 1% of balance||£120||£3,354||£354||28 months|
*Dependent on personal circumstances of the applicant.
Information correct at the time of writing.
In the table below, we’ve picked out some of the best loan rates available for different loan amounts to give you an idea of how they compare to credit cards. We’ve used a term of three years.
Example table showing how much interest you could pay on loan's of £3,000, £7,500 and £25,000
|Provider||Amount borrowed||Term||Interest rate||Monthly payment - set by lender||Total amount repayable||Total interest paid|
|AA||£3,000||3 years||8.8% APR*||£94.65||£3,407.48||£407.48|
|Cahoot||£7,500||3 years||2.8% APR||£217.33||£7,823.96||£323.96|
|Clydesdale Bank||£25,000||3 years||2.9% APR||£725.51||£26,118.45||£1,118.45|
* This rate is for AA members. Non-AA members will be charged 8.9% APR.
Information correct at the time of writing.
Is personal loan debt better than credit card debt?
Any type of borrowing can affect your credit rating and influence how you are viewed by mortgage providers and other lenders. If you are hoping to get on the property ladder, you may be wondering is it better to have loan or credit card debt when applying for a mortgage?
Ultimately, it doesn’t usually matter which type of borrowing method you use. Whether you have a credit card or personal loan, the key is to make sure you keep up with your repayments and pay on time. If you are late with a payment or miss it completely this will leave a mark on your credit rating.
Providing you make your repayments on time, keep within your credit limit and don’t overstretch yourself, taking out a credit card or personal loan can actually benefit your credit rating as it will show lenders you are a responsible borrower. If you have no credit history at all, providers may be less willing to lend to you.
When should you use a credit card?
On the whole, credit cards are better if you are borrowing a small sum of money, particularly if you can benefit from an interest-free deal. They are also a good option if you want some flexibility making your repayments and don’t want to be tied to a fixed amount each month.
Credit card purchases are also protected under Section 75 of the Consumer Credit Act. This means that as long as you have spent between £100 and £30,000, if the goods fail to turn up or are faulty, you can claim your money back. This can be particularly useful if you are buying online. Find out more in our article ‘When it’s best to pay by credit card’.
Credit cards are not only useful for spending purposes, however. You can also use them to consolidate existing debt. If you have existing credit card debt and you are paying interest, a 0% balance transfer credit card allows you to shift over your existing debt and pay no interest for a number of months. Be aware you will usually need to pay a transfer fee and once the 0% deal ends, you will pay interest.
You can find more information on balance transfer cards in our article ‘Best 0% balance transfer credit card deals’.
When should you use a personal loan?
A personal loan can be a good option if you need to borrow a large sum of money - perhaps to fund home improvements such as a new kitchen or extension. A personal loan may also be preferable if you want to stick to a budget as payments are fixed.
You can also get a personal loan to pay off credit cards. If, for example, you have balances on a number of different credit cards, you can move these across to one single loan. This can make managing your finances easier as you will only have one lender to pay each month, rather than several.
Things to consider before taking out a credit card or personal loan
Before you take out a credit card or personal loan, it is worth considering the following:
- What do you need the credit for? If it is a large purchase, is this something you could live without?
- Will you be able to afford the monthly repayments? If you are applying for a credit card, try to pay off more than the minimum amount each month. If you are applying for a loan, check what your repayments will be and whether they are affordable
- Do you know how much interest you’ll be charged? Keep in mind the advertised representative APR has to be offered to at least 51% of customers - but this means the remaining 49% may be offered a higher rate
- Have you checked your credit score? The better your credit score, the more likely you are to be accepted for the top deals
- Do you know what fees you might be charged? If you are applying for a balance transfer card, check the transfer fee. If you are applying for a loan, check whether there are fees for making overpayments
Before taking out a credit card or personal loan it is always best to consider your options carefully. Generally, if you need to borrow a large sum of money, a personal loan is likely to be a better option than a credit card. However, remember that monthly payments are fixed so you need to make sure you can afford to meet them each month.
Credit cards, on the other hand, can be useful if you are borrowing a smaller sum of money or need payments to be flexible. You may also be able to borrow interest-free for a set time. Just be sure to pay off more than the minimum each month as you will clear your debt more quickly and more cheaply.
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