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Loans vs Credit Card

There’s a right way to borrow money, and it won’t be the same for everyone. What are your circumstances? How much do you need? We talk through the pros and cons of the two most popular ways to borrow money: loans and credit cards.

In This Guide:

Loan or Credit Card: What’s the Difference?

A personal loan allows you to borrow a fixed, lump sum of money for a set term, which you pay back in agreed monthly payments with an additional interest rate. A short-term loan is repaid within a year, otherwise, your loan is considered to be long-term. Many personal loans also have origination fees, so be sure to check the terms before applying.

By contrast, a credit card allows you to borrow money up to a set credit limit, as agreed by your provider. This limit will depend on your credit history and credit scores, so whether you’re eligible to borrow the sum you need is something to consider. You’ll make purchases on your credit card and then pay off the balance, ensuring you make at least the minimum payment each month to avoid additional charges. You can continue borrowing this way up until your credit card limit is reached.

Whichever way you borrow money, make sure your credit report is in check before you do. Those with top scores get accepted for cheap loans and the best credit card deals. More than that, you must be certain you can keep on top of your repayments as otherwise fees and charges can quickly accrue and negatively impact your credit history.

Advantages of Loans

Structured Repayment Plan

One of the main benefits of taking out a personal loan is that it comes with a structured repayment plan. This means you will always know how much you owe each month and for how long, making it easier for financial planning.

Larger Borrowing Amounts

Personal loans typically allow you to borrow larger amounts of money compared to credit cards. If you need a substantial sum for an expense like home renovations, medical bills, or to consolidate credit card debt, a loan may be the better choice.

Lower Interest Rates on Larger Sums

Interest rates for loans can be lower than credit card interest rates, especially when borrowing a significant amount. Lenders often offer competitive interest rates for well-qualified borrowers.

Fixed Interest Rates

Many personal loans have fixed interest rates, meaning your monthly payments remain the same for the entire repayment period. This predictability is an advantage for long-term financial planning.

Potential for Credit Score Improvement

Making timely monthly payments on a loan can positively impact your credit scores. A history of consistent, on-time payments demonstrates financial responsibility.

Disadvantages of Loans

Less Flexibility

Loans have set repayment schedules, meaning you must adhere to the agreed monthly payments. This lack of flexibility can be a drawback if your financial situation changes unexpectedly.

Early Repayment Penalties

Some loans impose early repayment fees if you pay off your debt before the end of the term. This can be frustrating if you want to clear your debt ahead of schedule.

Application Process Can Be Lengthy

Applying for a loan can take time. Lenders may require extensive documentation, including proof of income, employment history, and a review of your credit report.

Interest Rates on Small Loans Can Be High

While larger loan amounts typically come with lower interest rates, borrowing a small sum may result in a high interest rate, making it a less attractive option.

Advantages of Credit Cards

Flexible Repayments

Credit cards offer more flexibility when it comes to repayments. You can choose to pay off the full balance each month or make smaller payments while maintaining the minimum payment.

Ideal for Small Purchases

If you need to borrow money for small, everyday expenses, a credit card is often the best choice. They offer the convenience of making multiple transactions up to a certain limit.

0% Interest Offers

Some credit cards offer introductory 0% interest deals, allowing you to make purchases without needing to pay interest for a specific period. This can be beneficial if you can repay the balance before the promotional period ends.

Protection on Purchases

Credit cards are protected by Section 75 of the Credit Consumer Act. If anything goes wrong with a purchase between £100 and £30,000, your credit card provider is jointly liable with the retailer.

Reward Schemes and Cashback

Many credit cards offer rewards, cashback, or travel points on purchases. If you use your credit card responsibly, these perks can be highly beneficial.

Can Be Used Internationally

Credit cards are widely accepted around the world, making them a convenient option for international travellers.

Disadvantages of Credit Cards

High Interest Rates

Credit card interest rates can be high, often ranging between 15% and 25%. If you do not pay off your balance in full, interest can accumulate quickly.

Temptation to Overspend

The ease of using a credit card can lead to overspending, which may result in a cycle of credit card debt if not managed responsibly.

Variable Interest Rates

Unlike fixed-rate loans, credit card interest rates can vary, making it more difficult to predict costs over time.

Minimum Payments Can Extend Debt

Making only the minimum payment each month means you could take years to pay off a balance, especially if interest accrues.

Should I Get a Credit Card or Loan?

When to Choose a Credit Card

  • You need to make small, everyday purchases.
  • You can pay off your credit card bill in full each month to avoid interest.
  • You want to take advantage of rewards and cashback.
  • You need protection on purchases.

When to Choose a Loan

  • You need to borrow a larger, fixed amount.
  • You want fixed monthly payments.
  • You are looking for a lower interest rate for long-term borrowing.
  • You want a fixed repayment plan with no temptation to spend more.

Alternatives to Loans and Credit Cards

Overdrafts

Some banks offer overdraft protection, allowing you to access funds when your bank account balance is low. However, overdraft fees can be high if not managed carefully.

Peer-to-Peer Lending

Peer-to-peer lending platforms allow individuals to borrow money from investors rather than traditional banks. Interest rates can vary but may be more competitive.

Home Equity Loans

Homeowners can borrow against the value of their property through a home equity loan or line of credit. This option typically offers lower interest rates but requires collateral.

Buy Now, Pay Later (BNPL) Schemes

Retailers often offer BNPL options, allowing you to spread the cost of purchases over several months without interest. However, missed payments can lead to penalties.

How to Improve Your Credit Score Before Borrowing

Check Your Credit Report

Review your credit report for any errors and dispute inaccuracies if necessary.

Pay Bills on Time

Consistently making monthly payments on time can boost your credit scores over time.

Reduce Your Credit Utilisation Ratio

Aim to use less than 30% of your available credit line to maintain a healthy credit score.

Avoid Multiple Credit Applications

Applying for multiple credit products in a short period can negatively impact your credit score.

Consider a Credit Builder Card

If you have a low credit score, a credit builder card can help improve it through responsible usage.

Final Thoughts

Choosing between a loan and a credit card depends on your financial needs, borrowing habits, and repayment capabilities. If you need a structured plan with fixed monthly payments, a loan might be best. If flexibility and convenience are key, a credit card could be the right choice. Always assess your financial situation and compare options before making a decision to ensure you borrow responsibly.

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