Deciding Between a Credit Card and a Loan
Credit card or loan? While these financial products aren’t exactly comparable they both serve a useful function. Take time to look at the details to see which one is better for you.
More from Choosing a Credit Card
6 January 2009
Deciding Between A Credit Card And A Loan
Whether you borrow money on a credit card or take out a loan, in both cases you will have to pay back the money you have borrowed.”
Whether you borrow money on a credit card or take out a loan, in both cases you will have to pay back the money you have borrowed.
In the case of a credit card there will be no interest to pay if you pay your balance back in full by the due date.
In the case of a loan you will have to repay back the amount, plus interest on the life of the loan and any other fees and charges that may be associated with it.
What is a loan?
Personal loans are either secured or unsecured.
A secured loan can only be applied for if you are homeowner, using your home as security. If you get into trouble with the repayments the lender could repossess your home and sell it to get their money back.
An unsecured loan is not secured against your home so if you can’t pay it back the lender can’t repossess your home. However you still need to keep up with the repayments as per the terms and conditions you agreed to when you took the loan out.
How does a loan work?
You borrow a fixed amount and have to pay it back in set instalments over a period of time (the term). The interest you pay is also usually fixed. Rates for secured loans are often lower, but this does not take into account extra fees and in this case, your home could be at risk if you do not keep up the repayments.
Early repayment
Often, if you can pay a loan back early there is a charge for early repayment and other fees. If you are considering a loan make sure you look at these details.
Late monthly payments
The safest way to avoid this is to set up a direct debit. Often, lenders will make this a condition of the loan. If you do pay late, you may be charged by both your lender, and your bank.
If you lose your income
Before taking out a loan bear in mind what you would do if you lost your source of repayment ability. Put in place some form of insurance, or other borrowing (such as family funds) to ensure that you don’t face a desperate situation if this does happen.
What is a credit card?
A credit card enables you to buy goods or services now and pay back later. This is called buying on credit. A credit card is not linked to your bank account and unlike a loan, only charges interest on any balance left on the card at the end of each month.
If you buy goods and pay them off by the repayment date, there is no interest to pay.
The downside of using a credit card
Because the card allows you to make purchases freely, within your credit limit, there is always the temptation that you may spend more than you can afford. This will lead to a balance left on the card and interest on this balance.
The APR (annual percentage rate) can be high on a credit card so this can end up making your purchases more expensive than you imagined.
Cash withdrawals
You are also at liberty to withdraw cash with your credit card. But if you do so, this cash is usually charged at a higher interest rate (the cash withdrawal rate) and it is likely that you’ll be charged from the day you take the money out. You will also be subject to a typical handling fee of 1.5% of the amount drawn.
The ways that credit cards are used more like loans
One of the biggest credit card trends in the past few years has been the use of a 0% or low interest rate card to do a balance transfer. If you have a balance - or several – sitting on other cards at any rate of interest it can be a money saving way to transfer the amount onto a 0% card. You then concentrate on paying as much as possible off, with the knowledge that all your repayments are paying the debt alone, without having to service the added burden of interest.
But there are fees
Most 0% credit cards do carry a balance transfer fee. This can be anything up to 3% of the amount transferred, which can mount up if you have a large balance. It may still be worth paying the fee if it enables you to use the 0% period to pay as much as possible to the balance. Some card providers don’t have a fee but they are few and far between.
The art of using the 0% interest period is to transfer again if you have a remaining balance but want to use 0% interest to continue paying the debt. It is essential that you do this in time however. It takes around six weeks for a new transfer to be processed. Making a note to do this in advance will enable you to move seamlessly from one 0% offer to another without any (interest) glitches.
Apples with oranges?
In some respects it is impossible to compare the merits of a loan against a credit card. They have different charging structures and the same balance on a credit card might incur lower charges than a loan. That is because if you pay your card balance off faster then you won’t be charged for doing so.
A loan agreement however, will often charge for early repayment.
There is also more flexibility with a credit card, although some people like the peace of mind and relative stability of a loan. This states that one fixed amount is paid in the same way every month, with the interest rates a known entity for the life of the loan.
