Credit Card vs. Personal Loan — Which Unsecured Loan Should You Choose?

You must make a purchase or spend some money, but you don’t have the money. If we leave out informal options like hand loans from friends and family, you must fund the expense through credit. Let’s assume the amount is not big enough for you to go through the pain of applying for a secured loan. Or let’s say you don’t have any assets to offer as security. In that case, you must go with an unsecured loan.

Unsecured loans can take many shapes. You can use your credit card. You can go for a personal loan (there are many types of personal loans). You can go to P2P lending sites to get credit. Let’s further assume that you need to make a choice between swiping your credit card or taking a personal loan. Which option would you choose?

By the way, both are loans. The difference lies in the repayment structures of the two methods. Let’s compare the two credit options, 3 factors to consider and see what will make a good choice for you.

#1 Speed of Disbursal. Credit card usage is instant. You can swipe your credit card and you get the credit. In case of personal loans, the application process is more formal and can be time-consuming. It may take a few days for you to get the credit.  Even though many banks and financial firms claim to provide instant loans, this may not happen for everyone. There are many factors including your credit scores considered. Hence, there is always an element of uncertainty about the loan sanction and disbursement timelines. Therefore, if you need money urgently, swiping your credit card looks like a better option.

#2 Amount. The quantum of loan is capped at your credit card limit. In case of a personal loan, you may be able to get much higher amount, depending upon your repayment ability. In this post, let’s assume this is not a factor.

#3 Repayment and Interest Rate. In case of personal loans, the loan tenure can be up to 5 years. You will have to pay interest from the date of disbursal. The interest rate will depend on your repayment ability and credit score and can range between 10% to 24%.  Much lower than credit card. Apart from that, there will be other ancillary charges such as processing fee that will increase the effective cost of your loan. Personal loans also have prepayment penalty. There is no GST on interest payment though.

With credit cards, you must make the payment by the next due date. Even in the best-case scenario, you would have to make the payment with next 45-52 days. If you repay by the next month’s statement due date, then you don’t pay any interest on the amount availed. However, if you can’t pay your credit card bill in full by the due date, it can become a huge problem. You will be charged interest rate from the date of purchase. The rates are exorbitant too and can easily be in excess of 40% per annum. There is GST too on credit card interest payments.

Making minimum payments won’t help beyond a point. Minimum payments can avoid hit to your credit score. However, it will not save you anything on the interest costs. In such cases, it may be prudent to convert credit card outstanding amount to EMIs. By the way, when you do that, all sets of charges associated with a personal loan come into picture. You will have to pay processing fee and other charges. Worse still, you will still have to pay GST on the interest component on EMIs. Therefore, if you foresee that you will have to convert your outstanding amount to EMIs, it is better to go with a personal loan.

What Should You Do?

Firstly, you need to see if you must take credit. Loans must be repaid. Therefore, you must exercise discipline while swiping your credit card or applying for a loan. Reckless spending due to easy access to credit can land you in financial problems. Assuming the expense must be incurred, and the choice must be made between a credit card and personal loans, the choice depends on your cashflows, how quickly you need the money and the amount of loan/credit you need.

If you think you can repay the credit card outstanding by the new due date, then credit card is a clear winner over a personal loan. You won’t have to pay any interest. You will earn some reward points too. A personal loan will be an expensive option in such cases. Not only will you have to incur interest cost and ancillary charges, the prepayment penalty will make it difficult to close the loan even when you have the money. A credit card is a better option for small amounts that you can repay in the next few weeks.

On the other hand, if the amount is big and you can only repay the amount over the next few months or years, a personal loan is a better option. In other words, if your cash flows are stretched and are likely to remain that way, it is better to opt for a personal loan that can provide a comfortable repayment schedule.

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