There comes a time in the life of most Americans when they need to borrow money for an unexpected expense. For most people, the first thing that comes to mind is a credit card. While this may be the best and only choice in some cases, it may not be the most fiscally responsible way to borrow money. If the financial need allows you to research borrowing options, you may find a more money saving choice. A personal loan or even a home equity loan may be a path that’s best suited to provide for your needs and save you some money. The question remains, which option makes the most financial sense…using a credit card or obtaining a loan?
Whether you should charge it or get a loan depends on several factors. But first you need to know the differences.
- Unsecured Personal loans The terms of the loan are fixed, meaning the interest rate and monthly payment remain constant through the duration of the loan. When you’re approved, you will receive a one-time check for the total amount you are borrowing. Unsecured loans generally have a higher interest rate due to the lack of any collateral for the bank to seize in the event the loan is not paid back. If you have something the bank will accept as collateral (e.g. car), you can lower the interest by establishing the loan as “secured”.
- Credit cards are also unsecured loans where funds are constantly available. The big difference is that the money you borrow is considered a revolving line of credit and the interest rate is not necessarily locked in. The account holder can use the maximum approved amount of credit in a variety of ways. Spend a little or the whole account’s limit; pay the balance off in full or pay the required minimum and carry over a balance from month to month. With most people already carrying a credit card, this option is usually the quickest.
- Home equity loans are offered to homeowners who are willing to put up their home as collateral. They work just like a personal loan; a lump sum is given to make a large purchase. Rates are typically lower than a personal loan.
Don’t automatically assume you’ll be granted the privilege of borrowing. A positive answer will depend on your unique financial situation. Factors that go into a bank’s decision to lend include:
Credit history/report: Confidential report on a your payment habits as reported by creditors to a consumer credit reporting agency. The agency provides the info to lenders who use it to determine loan eligibility.
Credit score: Your credit score is a numerical value that lenders take into account when deciding how creditworthy and how high of a risk approving a line of credit or loan to you is going to be.
Employment: How long you’ve been employed along with income levels are important components when determining whether or not you receive a loan or credit approval.
When a Personal Loan is a Better Choice
A personal loan tends to be premeditated, taking away the temptation to spend more than you can afford. They may offer a lower interest rate than the standard rate of a credit card without additional fees or interest, making it less costly for bigger purchases.
Being able to see the progress of paying down the loan each month can be rewarding. Unlike a credit card, the personal loan will show a continuous reduction in the debt without the potential setback from giving into the temptation to use more credit. Knowing exactly how much your bill will be each month and when the loan will be paid off provides security for many people, especially for those who follow a detailed financial budget.
When a Credit Card may be Better
For purchases that can be paid off in a short period of time, a credit card may be the best way to save money, outside of paying cash. While interest rates are generally higher than a personal loan, by using a low or 0% introductory APR card, you’ll pay little or no interest, so it’s important to avoid carrying the debt when the higher APR rate kicks in. Click here to learn more about low interest and balance transfer credit cards that may be able to help you avoid paying those high interest rates.
Borrowing with a credit card requires disciplined habits of money management due to the temptation of using the remaining balance available for frivolous purchases. It’s also important to pay as much as possible each month to avoid getting stuck in the minimum payment trap, never making headway on your balance and throwing money away on never-ending finance charges.
The Bottom Line
Consider all of your options before taking out any kind of loan or credit line. Credit cards are typically the best option for most purchases, simply due to their flexibility. If you need a larger amount of funding and own a home, opt for a home equity line of credit. Do you need the money right away or could you wait and save what you need? Do you make enough money to cover the added monthly bill? Is the amount of the loan more than what you really need? If you are unsure about the best option for your specific financial situation, I would strongly recommend that you speak to financial advisor to help work through the details and guide you into a fiscally responsible decision.
About The Author: Noreen Ruth is a regular contributor to a variety of financial-related blogs and websites. She specializes in credit and debt-related issues and enjoys educating consumers about the latest rules and regulations, as well as ways to build, improve and maintain good credit. Follow her regular posts on the ASAP Credit Card Blog to stay up-to-date with the latest credit card news, reviews, information and more. Asapcreditcard.com also provides a wide selection of credit card offers and a complete list of 0% APR credit cards.