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Both personal loans and credit cards offer a way to borrow funds and have many of the same standard credit provisions. In both loan and credit card agreements, you’ll typically find funds offered by a lender at a specific interest rate, monthly payments that include principal and interest, late fees, underwriting requirements, amount limits, and more. . Poor management of both types of credit can undermine your credit rating, causing problems with loans, access to good housing, job search
But in addition to the similar attributes that personal loans and credit cards share, there are also key differences, such as payment terms. Let’s explore the definitions and differences between the two, along with some pros and cons of each.
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Before we dive into comparing the differences between personal loans and credit cards, it’s important to understand one of the big similarities. The United States and most other countries have integrated a credit rating system that forms the basis for credit approval. The three major US credit bureaus (Equifax, Transunion, and Experian) are the leaders in setting credit scoring standards and working with lenders to enable credit approval.
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Credit scores are based on a person’s past credit history, including credit defaults, applications, accounts, and outstanding balances. Each individual is assigned a credit score based on this history, greatly affecting their chances of credit approval. In general, all of the factors taken into consideration by a lender can also affect the interest rate paid by a borrower and the amount of principal for which they are approved.
Lenders offer a variety of options within the personal loan category that can affect your credit terms. Generally speaking, the main difference between a personal loan and a credit card is the long-term balance. Personal loans do not offer ongoing access to funds like a credit card does. A borrower receives a lump sum up front and has a limited time to pay it off in full, through scheduled payments, and withdraw the loan. This provision generally carries lower interest for borrowers with good to high credit scores.
A personal loan can be used for many reasons. An unsecured loan can provide funds to finance large purchases, consolidate credit card debt, repair or improve a home, or provide financing to fill an income gap. Unsecured loans are not backed by collateral guaranteed by the borrower.
Home loans, car loans, and other types of secured loans can also be considered personal loans. These loans will follow standard credit approval procedures, but may be easier to obtain as they are secured by a lien on the assets.
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In a mortgage or car loan, for example, the lender has the right to repossess your home or car after a certain number of delinquencies. Secured loans generally have slightly better terms because the lender has property rights involved that reduce the risk of default. Here are some pros and cons of a personal loan.
Keep in mind that interest isn’t the only expense to consider on a loan. Lenders also charge fees, which can add to the overall costs of a loan. Personal loans typically include an origination fee and may have other fees as well.
One notable distinction is the difference between a line of credit (LOC) and a loan. Unlike a loan, a line of credit has built-in flexibility, its main advantage. One drawback is that it usually comes with higher interest rates.
An LOC is a predetermined loan amount, but borrowers don’t have to use it all. A borrower can access the funds from the line of credit at any time as long as they do not exceed the terms of the credit limit and other requirements, such as making minimum payments on time.
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An LOC can be secured or unsecured (most are the latter) and is usually offered by banks. One important exception is a home equity line of credit (HELOC), which is secured by the borrower’s home equity.
Credit cards belong to a different class of loan known as revolving credit. With a revolving credit account, the borrower generally has ongoing access to funds as long as their account remains in good standing. Revolving credit card accounts may also be eligible for regular credit limit increases. Interest rates are typically higher than personal loans.
Revolving credit works differently than a personal loan. Borrowers have access to a specified amount but do not receive that amount in full. Rather, the borrower can withdraw funds from the account at his discretion at any time up to the maximum limit. Borrowers only pay interest on the funds they use, so a borrower could have an open interest-free account if they don’t have a balance.
Credit cards can come in many varieties and offer a lot of convenience. The best credit cards may include 0% introductory interest periods, balance transfer availability, and rewards. At the other end of the spectrum, some may have high annual percentage interest rates combined with monthly or annual fees. Generally, all major credit cards can be used anywhere electronic payments are accepted.
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High-quality reward points cards can be extremely beneficial to a borrower who uses the benefits and pays off their balances on a monthly basis. Rewards cards can offer rebates, points for discount purchases, points for store-brand purchases, and points for travel.
Generally, credit cards can also be unsecured or secured. Unsecured cards offer credit without collateral. Secured cards are often an option for borrowers with low credit scores. With a secured card, the borrower is required to provide capital toward the card balance limit. Secured cards have different terms, so some may match your protected balance, some may offer an increase after a set period of time, and some may apply the protected balance to your card as payment after several months.
In general, each type of credit card will have its own way of accruing interest, so it can be important to read the fine print. Unlike personal loans, where the monthly payment is usually the same throughout the payment period, your credit card bill will vary each month.
Some credit cards offer borrowers the benefit of an educational cycle grace period that allows free funds to be borrowed. Other cards will charge interest daily, including the final interest charge at the end of the month. For cards with a grace period, borrowers may find they have about 30 days to purchase something without interest if the balance is paid off before interest begins to accrue.
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On the surface, financing with a credit card may seem like a simple option, but as with all loans, it’s important to do your due diligence. Credit cards can offer a great alternative to personal loans as they can be available at 0% interest and can offer some grace periods. Other benefits are also convenience points and rewards. However, as with any credit loan, interest and fees can be a significant burden.
If you’ve been stuck with an expensive card and are looking for something with a lower interest rate, there are several cards available today that are ideal for anyone looking to transfer their balance.
In general, revolving loans and credit cards make up a substantial majority of the total credit market. However, in addition to regular personal loans and credit cards, there may also be other credit products to consider. Here are some examples:
Corporate loans and corporate credit cards can be an option for all types of businesses. Corporate loan underwriting typically involves analysis of financial statements and projections. Corporate credit cards may be somewhat easier to obtain and offer the same benefits as personal revolving credit cards.
Personal Loans Vs. Credit Cards: What’s The Difference?
Payday loans are offered at extremely high interest rates. Borrowers use payroll to get cash advances. Payday loans can be considered predatory loans due to their reputation for extremely high interest and fees.
In general, lending can be a risky business that requires due diligence on the part of the borrower. The nature of credit agreements can create an opportunity for predatory lending and loan fraud, so it’s always important to understand the terms of your credit and make sure you’re borrowing from a legally licensed organization to protect yourself financially.
Not all credit is the same. Personal loans and credit cards can be structured with a wide variety of provisions and terms. Personal loans have relatively lower interest rates than credit cards, but must be repaid over a certain period of time. Credit cards provide ongoing access to funds and you only pay interest on outstanding balances that are not paid on time.
Regardless of whether you choose one or both, your credit score is the key to getting approved and favorable terms. When it comes to the former, a personal loan calculator can help you better understand how your credit score will affect your monthly payments.
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