Is a personal loan better than using a credit card?

We take a look at personal loans and credit cards and explain how they work and why one is better than the other in certain situations

Credit cards and how they work

A credit card looks very similar to a debit card and is issued by a bank/building society or a credit card company. They enable the cardholder to purchase items or to pay for services on credit. When you apply for a credit card the provider will review your application and if they accept it they will set a credit limit.

If you pay for something using a credit card, you borrow money from the card provider. It is often possible to use a credit card to make a withdrawal, but this will usually be at a higher APR than for spending.

Every time you use the card, the transaction will be added to the card balance. Each month the cardholder receives a statement, showing all the transactions made and the total balance of what’s owed.

Flexible borrowing

Credit cards offer a flexible way to borrow and they are often described as offering revolving credit. This means that you can use the card to spend up to a pre-agreed credit limit, then repay at least some of the debt each month, then use the card over and over again as required. All without having to repeatedly take out lots of separate credit agreements every time you wanted to use the card.

Card limits

The credit card company sets the cardholder a credit limit, which to start with may only be a few hundred pounds, but as their credit history and credit score improves, the limit may eventually be raised to thousands of pounds depending on the cardholder’s circumstances. However, if the cardholder goes over this limit, they will be charged a penalty fee unless they quickly get the account back in order.

Credit card repayments

You have the option of paying the card company everything from the minimum payment to paying off the total amount and anything in between. It is worth noting that you only make the minimum payment each month. It will take a significant amount of time to pay off the balance, resulting in paying out a lot in interest. If you pay off the card balance in full each month, you will not be charged any interest. It takes self-control to pay a card-off as there is no set time period to pay off the balance.

Rates from 0% to about 50%(!)

Some cards come with a 0% interest introductory offer that can last from a couple of months to a year. Remember, once the introductory period is over, the interest rate will usually revert to somewhere between 5% and 50% depending on your credit score and credit history. To receive and be approved for a 0% interest offer you have to have a very good credit score. To be given anything around a 50% rate you’ll probably have bad credit.

Personal loans and how they work

With a personal loan you apply for a certain amount, usually with a purchase or project in mind that you need financial help with. At the time of applying, the borrower will decide on the term (period of time) they want to repay the loan over. If your application for the loan is accepted, you receive a lump sum that is usually paid directly into your bank account. The personal loan is repaid each month in equal amounts over a set term and fixed APR.

At a personal loan can be for as little as £100 to as much as £35,000. This makes them a great option for everything from making large purchases such as a car to home improvements such as a loft conversion, to debt consolidation were you pay of smaller debts with one large loan.

Interest rates vary depending on the amount borrowed

The APR offered on a loan is often influenced by the amount you want to borrow. Often, the higher the amount borrowed, the lower the APR and the lower the amount, the higher the rate, but your credit rating and credit history will also be a big factor in the rate you’re able to secure.

Repaying a loan

Unlike with credit cards, with a personal loan you agree up-front to repay the amount owed (including the interest) over a set time period and using a fixed repayment amount.

The less time you take to repay, the less you will end up paying in interest overall and the longer you spread your repayments over, the more you’ll pay out in interest. At the end of the term, the loan will be completely repaid.

It is usually possible to repay a loan in full ahead of the agreed repayment schedule, but depending on the lender you may have to pay an early redemption charge.

So which method of borrowing is best?

In a word, neither. Both types of lending are good for certain situations.

Credit cards are useful for taking care of unexpected bills or emergencies, such as repair to your car or home. They are particularly useful if you travel a lot and are not sure if and when you will need a little extra spending power. They also offer a great deal of flexibility on repayments, but watch the interest rate you end up with.

It is best to keep an eye on your credit card spending so things don’t get out of hand. But if you suddenly find your card balance getting high, you may find that it’s a good idea to take out a personal loan to pay off the balance. Just don’t be tempted to run up a high balance on cards again.

A personal loan is ideal for those larger, more considered purchases or expensive projects. They usually will offer a far better, lower interest rate than a credit card will. Another advantage is that as long as you keep up with your repayments, you can be certain that the amount you borrow will be repaid in full as they don’t provide a revolving line of credit.

If you’re about to make a major purchase or have an expensive project in mind, see how could help you secure the best personal loan for you and your circumstances.

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