Personal Loan vs. Credit Card: Which option suits you best?
Personal loan: Credit cards are ideal for small purchases, offering rewards and cashback. Personal loans suit larger expenses with lower interest rates and fixed terms. Understanding both options helps individuals make informed financial decisions based on their needs.
When it comes to accessing funds, personal loan and credit card are two popular options offered by banks and non-banking financial institutions. Both are unsecured forms of credit, meaning they don't require collateral, and each comes with its own set of interest rates, repayment terms, and associated fees.
However, how you manage these financial tools can significantly impact your credit score and overall financial health. While both options can provide the necessary funds, they differ in terms of interest rates, repayment structures, and suitability for various financial situations. Understanding the nuances of each can help you determine which is the better choice for your needs.
Difference between personal loan and credit card
Let’s look on a comparison between personal loan and credit card:
| Parameter | Personal loan | Credit card |
| Documentation | Individuals must present many papers, including income statements, bank statements, and ITR returns, in order to apply for a personal loan. | Individuals just need to submit a few basic documents to obtain a credit card. Furthermore, in many circumstances, financial institutions issue pre-approved credit cards to certain consumers. As a result, credit card processing takes less time. |
| Interest | Interest rates are relatively high. It varies from 10% to 22% and is determined by the applicant's profile. | Monthly payments have low interest rates, ranging between 2-4%. However, APR is quite high and can reach 45%. Credit card interest is typically computed at a flat rate. This means that the interest amount is the same for each EMI, regardless of the principal amount.
|
| Tenure | The repayment period for personal loans is longer. Most lenders provide terms ranging from one to five years. | They have shorter repayment periods. It is commonly used to purchase goods or to cover short-term emergencies. |
| Loan amount | Personal loans might have a rather large loan sum. It depends on one's credit history and income level. | Credit cards can only be used to spend up to their predetermined credit limit. For example, let’s say that one has a credit limit of Rs. 60,000. He/she can only spend only up to that amount. If the individual spends Rs. 45,000, then the available limit will be Rs. 15,000 only. |
| Charges | Banks charge various costs, such as processing fees and late fees. | Credit cards have additional fees and charges, such as an annual percentage rate, a foreign exchange cost, cash withdrawal fees, and so on. The APR for these is really high. |
| Funds disbursement | Funds are distributed in a lump sum way. The lender transfers payments directly to the borrower's account. | The funds are promptly sent to the merchant or seller. Customers do not receive funds into their bank accounts. |
Personal loan and credit card: What’s the better choice?
Both personal loan and credit card serve distinct purposes and can be quite valuable. However, the best option depends on your specific needs. Credit cards allow you to borrow up to your credit limit repeatedly, making them ideal for everyday expenses and enabling you to earn rewards on each purchase. For larger expenses, personal loans are more suitable, as they typically offer terms of up to five years, which can better accommodate significant financial requirements.
Swapnil Aggarwal, Director of VSRK Capital says, "Credit card loans are a flexible option, allowing you to borrow up to your credit limit as needed. However, they typically come with higher interest rates, as the interest rate is subject to GST, which can accumulate significantly over time. For this reason, credit card loans are better suited for short-term needs.”
“Personal loans generally have lower interest rates, as they do not attract GST. These loans come with fixed terms and repayment schedules, which makes them ideal for larger, long-term financial needs,” Aggarwal added.
When should you opt for a personal loan?
Personal loans are better appropriate for large-ticket purchases. A personal loan can be used in the following situations:
Unexpected medical expenses: Individuals with unexpected medical bills that exceed their medical insurance coverage might apply for a personal loan. Despite the exorbitant costs, they are useful for dealing with medical situations.
Debt consolidation: Individuals with multiple loans might consolidate them by applying for personal loans. It will help them to consolidate their debts and repay them within the timeframe indicated.
Wedding expenses: People who are getting married or arranging a significant cultural or religious event can apply for personal loans.
(These are just few examples of how individuals use personal loans)
When should you opt for a credit card?
Here are some popular uses of a credit card:
Purchase: Individuals can use credit cards to make purchases that are within their credit limit. Financing the purchase with affordable EMIs can help alleviate the financial pressure. These are primarily for small-ticket goods and daily needs.
Cashback and rewards: Making a purchase or paying payments with a credit card might earn you rewards or cashback points.
(These are just few examples of how individuals use credit cards)
Conclusion
Whether to opt for a personal loan or a credit card often hinges on individual circumstances and financial goals. Ultimately, the most effective strategy involves using both personal loan and credit card judiciously. By understanding the advantages and disadvantages of each option, individuals can make informed decisions about their finances and work towards achieving their financial goals.
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