Should I use a credit card or a personal loan?
You should think carefully before jumping in to any kind of borrowing. Interest rates, terms and conditions, hidden admin fees and redemption penalties, the length of the repayment plan… all of these will vary according to the different type of credit being offered.
But when it comes to choosing between borrowing on a credit card or taking out a personal loan, the number of factors that will help you to make the right choice is considerably smaller and will very often simply revolve around how much money the applicant wants to borrow.
While there are some extremely good interest rates available on personal loans, a general rule of thumb is that the more money you want to borrow, the more you are going to end up paying back in interest and other charges. That is despite most loans offering higher interest rates for smaller amounts. That may sound like a contradiction but it is simply down to the interest charged on the capital sum – a 1 or 2 per cent lower APR is not going to translate to a cheaper loan overall if you are borrowing a significantly larger amount.
Credit cards
So that means that if you need to borrow less than £3,000 a credit card might end up costing you less to borrow against than a personal loan. This is particularly true for people with outstanding borrowing with higher APRs – maybe other credit cards or store cards – and want to roll these onto one credit card offering a lower introductory rate.
For those in this position, a number of credit card companies offer what are known as balance transfer cards. These come with interest-free or low interest introductory periods – usually 12 or 18 months – when you won’t be charged interest on the balance. But remember that many of these companies will charge you an initial balance transfer fee, which could be up to 5 per cent of the amount you are transferring.
If you are looking to borrow money to buy something – perhaps a new sofa, a holiday or a new computer – then it is not a balance transfer card that you should be looking for. Many credit companies offer low introductory interest rates. These introductory periods are usually only available for 12 months before the interest rate reverts to the lender’s standard variable rate.
People who are planning to borrow money for different reasons should think about loans that offer interest free periods on both purchases and balance transfers. There are a number of organisations now offering these.
But be under no illusions: none of these cards are a free lunch. It may appear that they are a means of borrowing money at low or no cost, but this is an illusion unless you are absolutely rigid about paying all of the money on the balance before the introductory period comes to an end.
When that introductory period finishes, the interest rate will suddenly shoot up, rising to 17, 18 or even more than 20 per cent per month. That means that if you have, say, £5,000 outstanding on your card balance, your repayments could double from a relatively modest £100 a month to £200. If you only ever make the minimum repayment each month, you could end up carrying this debt for years.
So, this means that borrowing money on a credit card should only ever be an option for people who have the sufficient discipline to repay the entire balance before the introductory period.
If you are not confident that you are going to be able to do this, then you should consider borrowing using a personal loan which will have a set repayment schedule during which you will repay the entire amount plus interest over one, two, three, five or perhaps seven years.
Personal loans
A personal loan will usually come with a fixed interest rate and a longer repayment schedule. So an applicant will be able to plan their repayments and budget for, potentially, years ahead. While the APR will always be higher than an introductory period on a balance transfer or purchase card, the rate will generally be lower than that of the card once the initial interest free period has ended.
If you have an impaired credit record and you want to borrow a larger amount and will need longer than a year to pay it back, you will probably find a lender willing to consider an application from you. There are generally fewer lenders willing to offer credit cards to people with bad credit than those offering personal loans to this market.
Some people with particularly poor credit records may struggle to get a personal loan. Those that do have an application accepted are likely to have to pay higher interest rates than those with perfect credit records. However, the market for personal loans is big and expanding rapidly with this increased competition seeing lower and lower interest rates offered on new loans every month.
If you’re unsure about your credit status, you can get your credit reports from the three main credit reference agencies – Experian, Equifax and CallCredit.
Personal loans are available for sums from £1,000 to £10,000. There are, however, other lenders who are prepared to accept applications for much higher amounts – sometimes as much as £25,000. Repayment periods vary with the shortest being 12 months with the longest stretching out to 10 years. Most people opt to repay their loans over either three or five years.
Article provided by Mike James, an independent content writer working together with Solution Loans, a technology-led finance broker with many years experience in helping clients to find the right type of credit..
