Got something you need to use credit for and not sure whether to get a loan or use a credit card? What’s the difference? Our friends at NerdWallet are here to break it down for you.
Managing Unplanned Expenses: Personal Loans vs. Credit Cards
Many American families are constantly juggling debt and the interest payments that go with it. The average household with debt pays a hefty total of $6,658 in interest per year, according to an 2015 analysis by NerdWallet. How you manage short-term debt can make a big difference in how much interest you pay.
The question is, when you need to cover big unplanned expenses, what makes more sense: using credit cards or taking out a personal loan? The answer depends on your particular situation.
Credit Cards 101
Credit cards are a type of open-ended, revolving financing that you can use to borrow as little or as much as you need, within your credit limit. This option comes with a few additional advantages:
- No closing costs or annual fees: Many credit cards, like those offered by Great Basin Federal Credit Union, are free to use aside from any incurred interest or late charges.
- Fixed interest rates: Some financial institutions provide fixed rates that won’t increase over time.
- Grace periods: By paying your balance in full before the end of each billing cycle, you can avoid having to pay interest.
- Travel accident insurance: In the unlikely event that you’re in an accident while traveling, some cards provide travel insurance protection.
Introduction to personal loans
A personal loan is an installment loan, generally with fixed interest rates and terms ranging from two to five years. Personal loans don’t require collateral, and the money can be used for anything: debt consolidation, auto repairs, travel, even cosmetic surgery. Personal loans have several advantages:
- Predictable payments: With a fixed interest loan, your monthly payments will never change. This allows you to pay off debt faster and for less than you could by making minimum payments on a credit card, and it makes budgeting easy.
- Steadily declining debt: Because this financing is closed-ended, debt can never increase and declines at a predictable rate.
- Get as much as you need all at once: If your borrowing needs exceed your credit card limit, personal loans may provide a solution, in some cases allowing you to borrow up to $10,000.
- No prepayment penalties: Personal loans generally let you pay off your balance early with no additional fees.
- Skip a payment: Some financial institutions provide an option to skip one loan payment annually.
Which one makes more sense?
Credit cards and personal loans can both be effective financing approaches. A personal loan can be a better choice if you need a longer time period — such as a year or more — to pay off your expenses.
It can make sense to stick with credit cards for smaller expenses that can be paid off within a few months, especially if you can pay the bulk of the balance during the first grace period before any interest applies.
Keep in mind, though, that If you decide to finance with credit cards, discipline is essential. You don’t want to charge new purchases before the old ones are paid off and see your debt growing out of control.
By picking the right option for dealing with the unplanned expenses in your life, you can keep the amount of interest you’re paying down to a minimum and work toward getting debt-free.
Roberta Pescow, NerdWallet
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