Credit Card or Personal Loan: Which One Has the Best Interest Rate?

Given the choice, most people would rather put a large expense on a credit card than pay for it with a loan. It’s so much easier - there’s no application or vetting process, they can pretty much decide how much to pay each month, and there’s no date by which it’ll have to be paid off. They’ll be paying for the convenience, though, in the form of interest fees that are charged every month. With personal loans, on the other hand, they would also be paying interest, but it’s possible to get a loan with much lower rates than your average credit card would offer.

So, what benefits could personal loans give me that credit cards can’t?

In order to answer this question, I’ll have to back up a little bit and talk about credit scores first. A person’s credit score is calculated on a whole bunch of factors, like how long they’ve had a credit card, how punctual they are with paying bills, how many credit cards they have, and whether they keep a high or low balance on their cards. By looking at someone’s credit score, it’s possible to get an idea of how responsible they are with their financial commitments. For example AmOne loans usually charge around 3.99% for people with less than average credit credit scores, but a local credit union might charge 2%.

Now let’s move on to talking about personal loans, credit cards, and interest rates. If you have a balance on your credit card that carries over month to month, you’re probably paying about 16% interest on it. If there’s not much of a balance left from the previous month’s billing cycle, that won’t be too much of a blow to your finances. We’re talking about the kind of money you might need a loan for, though. With those amounts, a 16% interest rate could turn into an overwhelming number if you leave it long enough.

That’s where personal loans start to look more appealing. If you have a fairly good credit score – say, high 600’s or above – then you could expect to pay about 10% - 12% interest on a loan. An important note: you’ll also be paying a lender’s fee of 1% - 8%, but the bigger the loan is, the smaller the lender’s fee will be. With a good enough credit score and the right loan amount, you could save a good chunk of money on interest payments.

Why can’t I just charge everything to my credit card and deal with the interest fees later?

Nobody gets money for free, and you usually can’t get it without interest charges either. If getting the best interest rate possible isn’t something you want to worry about, more power to you…but that’s not something that any financial expert would ever recommend. Credit cards are set up to be easy to use, not easy to pay off. You could max out one card after another with no immediate consequences, but in the meantime, things could get out of hand. While you’re coasting along with the minimum payments of $20-$30 per month, the total balance will be building up interest faster than you’re paying it off. Unless you started to increase the monthly payments, you’d end up with a gigantic credit card balance, and no way to take care of it. 

That’s probably the main disadvantage of using credit cards for large expenses, and honestly, a lot of people could avoid it if they just knew a little more about how their cards worked. Getting a loan can seem intimidating, but if you know you’re going to be paying a large expense off for at least a year or two, you’ll come out ahead even if you only get marginally lower interest rates.

So far I’ve mostly been recommending loans over credit cards, but let’s look at the other side of the argument for a minute. Not everyone has a good enough credit score for a loan to be more cost-effective than a credit card, so in some cases, that 16% interest rate could be the best they’ll get. Also, lending firms don’t give their clients rewards, but credit card companies most definitely do. Unless you’re an 18-year-old with a weekend job and no credit score, you should be able to get a card with pretty appealing perks, such as cash-back offers, points to spend at certain stores, or brand discounts. There are even cards that offer 0% interest for the first 12 to 18 months, which could be a nice little loophole for when you’re paying off your next big purchase. For some people, the rewards they get actually make the interest rates worth it.

How do I pick one option or the other if both interest rates will end up nearly the same?

That all depends on how fast you want to pay the money back, and how much interest you’re willing to pay. With your credit card, you have all the time in the world to pay back what you owe – just know that you’ll have to pay it back eventually. The amounts of the monthly payments are totally up to you, so long as they meet the monthly minimum. The drawback is, this approach isn’t sustainable at all, and you could actually end up owing more in interest than for the original balance.

With a loan, you’ll know from the beginning when the amount will have to be completely paid off. You’ll be paying the same amount each month, and you won’t have the option to procrastinate or ignore the payment schedule.

If you’re confident that you can be consistent with paying off a large credit card balance, then by all means use your credit card and enjoy those user rewards. However, if you know that you need some extra motivation to stay on track, then a loan would probably be the best option for you. Since money doesn’t grow on trees, these things can get a little more complicated than just raiding the backyard orchard; but fortunately, it doesn’t have to be as difficult as it seems.