Here, we’ll walk you through the difference between loans and credit cards to help you make the best financial decision the next time you need to finance a purchase, no matter how large or small.
Personal Loans and installment loans
You’ll get a loan for a one-time expense. It isn’t an open line of credit that you can use when you please. The interest rate and payment amount will not change, and you’ll agree to the terms at the beginning of the loan.
Personal and installment loans don’t require collateral, so the lender depends on your FICO credit score to determine if they’ll grant the loan, what interest rate they’ll charge, and how long they are willing to stretch out the payments. You can usually get a larger amount of money with a personal or installment loan than you can with a credit card.
How to get a personal loan or installment loan
In general, you’ll need a good credit score to get a personal loan or installment loan with a low interest rate and good terms. Loans for bad credit are widely available, but you’ll pay a much higher interest rate as well as initiation fees.
Unlike credit cards, you’ll pay back a personal or installment loan over a pre-determined amount of time. The lender decides how long they’ll give you to pay back the loan.
If you are interested in a personal or installment loan, pay special attention to the terms, fees, and interest rate. Make sure the payment fits into your budget. The lender may report to one or more of the three major credit bureaus. This could work in your favor if you are building your credit and you make every payment on time.
This type of financial product is at revolving debt. That means the bank or company that issues the card sets a limit on how much you can owe them at any one time. You can charge your credit card up to the limit or just use part of the credit line.
There are credit cards for almost any credit score. If you have bad credit, or a low FICO score, your interest rate will be much higher than if you have great credit. Credit cards also charge fees for late payments and some charge a fee if you go over your credit limit.
A credit card offers a good way to build credit if the company issuing the card reports to all three major credit bureaus each month. Making on-time payments on a credit card helps raise your score. It’s important to understand that the percentage of your available credit you’ve used has a big effect on your credit score, as well. Your FICO score will dive if you max out credit cards.
What to know about getting a credit card
If you decide to get a credit card, resolve to pay off the balance each month before the grace period for new purchases is up. You won’t pay interest on your purchases, and you won’t risk late fees or damaging your credit score by carrying a balance of more than 30% of your available credit.
How Do Credit Cards Affect Your Credit?
Like most personal and installment loans, credit cards can help your credit score by giving you a history of on-time payments. However, there’s more of a balance you need to be aware of to make sure you’re not inadvertently hurting your score.
For instance, a high balance can cause your score to drop and is viewed as a higher risk by lenders. You typically want to make sure your balance stays under 30% of your credit limit. If you need to make a large purchase that puts you over this amount, you may want to consider an installment loan instead, especially if you know you can comfortably meet the monthly payments each month. Otherwise, your credit score could drop and you may notice your interest rates rising, either on your existing credit cards or when you go to apply for new credit.
How to Use Personal Installment Loans to Consolidate Credit Card Debt
If you already have credit cards with high balances, it may be wise to pay them off with funds from a personal installment loan. You may be able to get a much lower interest rate on a loan than you pay on your credit cards. You’ll make fixed monthly payments, which you can work into your budget.
If you decide to consolidate your credit card debt by taking out a loan, make sure you can resist the temptation to charge new purchases to your cards. You’ll save a lot of time and money by avoiding major credit card debt and consistently paying down your personal or installment loan.