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If you have a big purchase coming up, there are lots of reasons why you might want to pay for it with a credit card or a personal loan.
Even though using cash is the best way to stay out of debt and make sure you’re buying items you can afford, credit cards and personal loans – when used strategically – are helpful for a few reasons.
Before diving into personal loans vs. credit cards, let’s first talk about why you’d consider either of these options over using good, old-fashioned cash.
Why Are Credit Cards Or Personal Loans Better To Use Instead Of Cash?
You do NOT want to borrow money to pay for something before you have the cash on hand. So, to clarify, here we’re talking about when to use a personal loan or credit card to buy something and pay it off quickly with the cash you do have on hand. It’s an important distinction.
In this situation, the main reasons why people use credit cards or personal loans over cash come down to three main things:
- Cash Flow
Let’s start with the first one: Convenience.
Sometimes, especially when a significant purchase is unexpected such as surprise car maintenance or a broken dishwasher, a credit card is the most convenient way to pay.
Even when you have the cash in your emergency fund, using a credit card is faster and more convenient than transferring money on your cell phone in the store, especially when the sales rep is about to give you the deal of a lifetime.
In these scenarios, credit cards provide a super convenient way to swipe now and pay later.
Cash flow is the second reason why people turn to personal loans or credit cards to buy major items.
If you have a monthly budget of $3,000, and you want to buy a new dining room table that costs $1,500, rather than drain half of your monthly budget into a one-time purchase, you can pay for it up front with a loan or a credit card, then repay the balance at the end of the month or, yes, over time if you need to.
This strategy is most beneficial when your loan or credit card comes with special financing. For example, many credit cards offer a 0% APR Intro period of 12-18 months.
Many furniture and electronics stores also offer a 0% financing option in the form of a store credit card or personal loan. It’s always smart to take advantage of a 0% financing deal if you don’t want to drain your savings for a big purchase and would rather pay off your dining table (or whatever your purchase) over time.
This scenario offers you a way to wrap a big purchase into your monthly cash flow without breaking the bank – and if you can do it without paying interest, the better that bodes for you!
The last reason why people turn to credit cards over cash for big purchases is because of the rewards.
Let’s say you have been saving for a large amount of new furniture, and there’s more than the $10,000 you need sitting in your bank account. When it’s time to pull the trigger on your new bedroom set and sofa, you could theoretically walk into the store and pay in cash, no financing needed.
In this scenario, why would you want to put it on a credit card? Well, imagine your credit card comes with 1.5% cash back rewards on all purchases. If you earn 1.5% on a $10,000 purchase, that’s $150 cashback that would automatically be credited to your balance or deposited directly into your checking account. Why wouldn’t you want to take advantage of a free $150?
Plus, you may even be able to earn a cash bonus if you plan ahead and open a new credit card before making your major purchase. This could add an additional $200 or more back to you just for buying the furniture you were already planning to buy.
So now that you know the reasons why it might make sense to consider using a credit card or personal loan to pay for a big purchase, let’s talk about which one is better for you.
Is It Better To Get A Personal Loan Or A Credit Card?
When it comes time to make a significant purchase, there are so many options that it’s hard to know what’s better in the scenario of credit card vs. personal loan.
The answer comes down to a few questions. Here’s what you should ask yourself when deciding between a personal loan vs. credit card:
What Is The Interest Rate?
The primary perk of using a credit card vs. a personal loan is that if you have a good credit score, you’re likely to find the best interest rates.
That’s because many credit cards offer 0% intro APR periods that let you pay off your balance for a period of 12-18 months interest-free, making financing something much more manageable.
On the other hand, if you don’t qualify for a new 0% APR credit card, or need to purchase something more expensive than a single credit card’s credit limit, a personal loan will likely have a lower interest rate than a standard credit card APR.
Most credit cards after their intro APR periods have annual interest rates between 12-27%, whereas personal loans might dip as low as 5% and reach as high as 19% for borrowers with good or average credit. Just be careful: Some lenders will approve personal loans to borrowers with less-than-average credit at interest rates of 30% or more. Borrower beware: We can’t think of a situation in which we would recommend taking on debt at such interest rates.
How Much Do I Need To Borrow?
This question is super important because:
- You’ll need to know whether your credit card limit is high enough to charge it, and
- That’s how much you’ll have to pay off within a certain time.
Personal loans are often available in amounts of up to $50,000, which is higher than most credit limits on credit cards.
What’s My Plan For Paying It Off?
The great thing about personal loans is that they are fixed loans, financed for a particular period of time. Once your repayment period is over, you’re done!
For example, if you take out a personal loan with a three-year repayment period, your monthly payment is calculated by adding the total amount of interest accrued over the period of the loan to the principle and dividing it up among 36 months.
A $5,000 personal loan with 7% interest and a 3-year term would mean monthly payments of approximately $154. The bank makes about $558 off of your business, and you get a low monthly bill. When the loan is paid off, you are finished, and you can move on.
On the flip side, credit card accounts stay open, meaning once you pay off your purchase, you must be disciplined not to charge excessive items to your card. It’s up to you to develop the discipline of only spending what you can pay for during the length of time that your line of credit stays open.
Is There A Penalty For Paying Off The Balance Early?
Credit card companies never charge you for paying off your balance since your credit line remains open, whether you have a balance or not. As long as you stay out of revolving debt, this is great!
Many personal loan companies don’t charge for paying off a balance early. However, some lenders do charge early repayment penalties because they lose out on projected interest when you pay your debt off earlier than expected. Most reputable lenders won’t charge a pre-payment penalty. But, if you want to get a personal loan, make sure to ask this question.
What’s Worse for Your Credit, A Personal Loan Or Credit Card Debt?
The credit bureaus like to see a healthy mix of credit card debt and other kinds of debt on your credit history, but in this case, taking on debt for a large purchase is nearly the same in the eyes of credit reporting agencies.
The “type” of debt won’t affect your credit score, so much as your reliability in paying it off. So no matter what route you choose, be sure to make all payments on time, aim for lower interest rates to keep your monthly payments reasonable, and only stay in debt the minimum amount of time necessary to reap the maximum rewards.
Good luck, and spend wisely!