How to decide whether you should use a credit card or a loan to borrow money

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credit card or personal loanApeloga AB/Getty ImagesApeloga AB/Getty Images

  • Credit cards offer a convenient way to borrow money, but that convenience comes at a cost. After all, the average credit card interest rate is currently over 17%.
  • Personal loans come with fixed interest rates as low as 5%, fixed monthly payments, and a fixed repayment timeline.
  • While personal loans are usually best for people who need to borrow with a plan, some credit cards - including 0% APR balance transfer cards - let you take out a loan interest-free for more than a year.
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No matter how financially responsible you are, it's possible there will come a time when borrowing money is the only way to stay afloat. Maybe you racked up some credit card debt that you desperately need to consolidate at a lower interest rate. Perhaps your car broke down and you need a new one to get to work, your kid suddenly needs braces, or your house needs a new roof and insurance won't help.

There's no use feeling bad about your situation, and it certainly won't help to dwell on your financial woes. What you can do is make sure you're borrowing money in a responsible way - a way that will help your finances instead of harming them.

While there are numerous ways to get a loan when you need one, most consumers who need to borrow money to consolidate debt, pay for emergency expenses, or cover other essential purchases choose one of two options - either a personal loan or a credit card.

Which option will work best in your situation? Well, that depends.

Credit cards: the good and the bad

When you need to borrow money in a pinch, credit cards are often the easiest way to go. You can apply online and from the comfort of your own home and receive your card in the mail within a few business days. Plus, credit cards tend to offer consumer protections and rewards programs that can make using them seem like a lucrative and safe endeavor. Some credit cards known as balance transfer cards even let you pay 0% APR on purchases or balance transfers for up to 21 months, although a balance transfer fee of 3% or 5% may apply.

Unfortunately, credit cards have plenty of downsides, including the fact that the average interest rate is now over 17% APR. That's a lot of interest to fork over every month - especially if you have a large balance and need a lot of time to pay it off.

Since credit cards offer a line of credit instead of a fixed amount of money upfront, using them can also become a slippery slope. It's far too easy to use credit to pay for purchases you can't afford, then make a small payment each month, letting your balance balloon over time.

Speaking of small payments, credit cards offer the option to pay a very small amount of your balance each month known as a minimum payment. This payment usually works out to 2% or 3% of your balance each month. A small amount like this may work into your budget nicely, but it can also leave you paying off your credit card debt for years or even decades to come.

Let's say you need to borrow $10,000 to cover a new roof and you choose to do so with a credit card that charges 17% APR. If you paid only 2% of your balance each month, it would take you 88 months to pay it all off - and only if you quit using your card for other purchases. You would also pay a bare minimum of $7,518 in interest during that time.

While using credit can make sense if you need to borrow money fast, consider the pros and cons before you take the plunge.

Advantages of credit cards:

  • A balance transfer card that offers 0% APR may let you avoid paying interest on balance transfers and/or purchases for nine to 21 months.
  • Credit cards are easy to apply for and convenient to use.
  • If money gets tight, you have the option to pay a small minimum payment each month.
  • Since credit cards offer a line of credit, you only need to repay amounts of money you borrow.
  • You can earn travel rewards or cash back and score important consumer perks like extended warranties, guaranteed returns, and travel insurance.

Disadvantages of credit cards:

  • Interest rates tend to be high; the average credit card APR is currently over 17%.
  • Without a set monthly payment, it's easy to pay the minimum amount and wind up paying your debt off longer and spending more in the long run thanks to the high interest.
  • Credit cards make it easy to overspend and get stuck in a cycle of debt.

Personal loans: the good and the bad

If you're worried how credit cards might harm you in the long run, personal loans provide a more predictable way to borrow money. Unlike credit cards that come with line of credit you can borrow against, personal loans offer a set amount of money with a fixed interest rate and a fixed monthly payment. Personal loans also feature fixed repayment timelines, meaning you will always know exactly when your loan will be paid off.

If you're worried about the process of applying for a personal loan, you shouldn't be. You can easily compare and apply for personal loans online and without ever visiting a bank, and you can often get your loan funded within a few business days. Plus, many personal loans for people with good credit offer fixed interest rates as low as 5% APR.

You can compare your options for a personal loan through sites like Credible, LendingTree, and SoFi.

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And, while some personal loans do charge fees like an origination fee or application fee, most people with good credit can qualify for a personal loan without any fees.

The downsides of personal loans aren't quite as several as the pitfalls of using credit cards, but that doesn't mean personal loans are perfect. Here are the main pros and cons to be aware of:

Advantages of using personal loans:

  • With good credit, you can pay a fixed interest rate that is typically much lower than ones charged by credit cards.
  • You'll have the same monthly payment each month and you'll know exactly when your loan will be paid off.
  • Since personal loans give you a fixed amount and don't offer a line of credit, they don't tempt people to overspend like credit cards do.

Disadvantages of using personal loans:

  • The loans with the best interest rates and terms typically go to those with very good or excellent credit - or individuals with FICO scores of 740 or higher.
  • You don't have the option to make a smaller monthly payment each month since your interest rate, payment, and repayment schedule are fixed.
  • Some personal loans have fees, such as an origination fee.

Credit cards or personal loans? Here's how to decide

While there are exceptions, credit cards are usually best for people who need to borrow money in the short-term and pay it back within a few months. However, 0% balance transfer credit cards can be good longer-term options since they let you avoid interest for up to 21 months. Before you go this route, however, you should make sure you have a plan to repay your balance before the 0% introductory offer is up.

While cards that dole out rewards are an attractive option for consumers, you probably shouldn't consider them if you plan to carry a balance. After all, most rewards cards offer 2% or 3% back at most, and that's a lot less than the interest you'll be paying.

On the other side of the coin, personal loans work best for consumers who need to borrow for a specific goal like a home remodel or major home repair since they come with predictable payments and a fixed timeline for when you'll pay them off. However, they also work well for debt consolidation when consumers don't want to deal with the temptation of having a credit card around.

Before you choose between these two borrowing methods, figure out how much cash you need and how long you need to pay it back. Then play around with a personal loan calculator and a credit card calculator to create a few different repayment scenarios you can compare.

From there, choose the option that provides you with a monthly payment, interest rate, and repayment timeline you can live with. The prospect of borrowing money may be stressful, but you'll feel better once you've taken time to compare all the options - good and bad.  

Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.

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