- Credit cards: Revolving credit
- Personal loans: Instalment credit
With a credit card, you are approved for a credit limit, and you can borrow up to that limit multiple times as long as you make at least the minimum payment each month. Interest is usually applied to any remaining balance at the end of your billing cycle.
In contrast, individuals who take out a personal loan receive a one-time lumpsum that they are required to repay in consistent monthly installments over a set loan period, typically ranging from one to seven years. Interest is generally applied to the entire loan amount from the start, eliminating the concept of a revolving balance.
When should you consider using a personal loan?
Personal loans provide a lumpsum of money upfront, making them ideal for addressing unforeseen expenses such as car repairs or a new roof. They can supply the funds necessary to renovate your kitchen, bathroom, or other parts of your home, offering a fixed repayment plan to help you manage the expenses.
By combining several debts with higher interest rates (like credit cards) into one personal loan with a lower rate, you can streamline your payments and potentially reduce your long-term interest expenses. Here are some further advantages of using personal loans for these purposes:
- Predictable payments: Fixed monthly installments simplify budgeting.
- Potentially lower interest rates: Compared to credit cards, potentially saving you money in the long run.
- Credit score improvement: Making timely payments on a personal loan can gradually enhance your credit score.
Certainly, it’s important to also consider the disadvantages:
- Not suitable for everyday purchases: The application process and repayment structure make them less ideal for daily expenses.
- Potential credit score impact: Applying for a loan can result in a temporary reduction in your credit score.
When should you consider using a credit card?
Credit cards are convenient for daily expenses like groceries, gas, or online shopping since there’s no need to apply for a new loan each time. To fully reap the benefits of credit cards, it’s essential to pay off your balance in full by the due date. By doing so, you can avoid interest charges, essentially transforming your credit card into a free, short-term loan.
Numerous credit cards feature rewards programs that provide cash back, travel points, or other advantages on your purchases. Settling your balance completely enables you to reap these rewards without incurring any interest charges.
Here are a few more points to keep in mind:
- Risk of overspending: Using a credit card can lead to overspending, making responsible credit card management crucial.
- High APR: Carrying a balance on your credit card can result in steep interest rates (APR), potentially leading to substantial debt if not handled carefully.
Understanding these two credit types is essential for making informed financial decisions. While credit cards can be a handy tool for daily expenses and credit building, it’s crucial to avoid maintaining a balance due to their high interest rates. On the other hand, personal loans are more appropriate for significant expenses where you require a predictable repayment schedule and a lower interest rate.
Frequently Asked Questions (FAQs)
Q. How do you decide between a personal loan and a credit card for consolidating debt?
Both personal loans and credit cards can serve as tools for debt consolidation, but each option comes with its advantages and disadvantages.
There are certainly advantages to using a personal loan for debt management. Firstly, these loans often come with lower interest rates compared to credit cards. Additionally, they offer fixed monthly payments and a set payoff date, helping you maintain discipline and avoid accumulating more debt.
Individuals applying for personal loans typically need a good credit history to qualify, may encounter origination fees, and cannot be used for new purchases as with a credit card.
Credit cards often come with lower introductory interest rates for a limited period, which can be convenient if you already have a credit card. These cards usually include a balance transfer fee and may have a high interest rate after the introductory period. There’s also the temptation to continue using the card and accumulate more debt.
Q. How do you define a personal loan?
A personal loan is an unsecured loan that is deposited directly into your account and must be repaid with interest over a set period. Unlike revolving credit, such as credit cards, a personal loan concludes once the loan is fully repaid. These loans are unsecured, meaning you don’t need to provide collateral such as a car or house in the event of loan default.
Upon approval, you usually receive the loan amount as a single lumpsum deposited into your bank account. You then repay the loan with interest over a set period, typically ranging from two to seven years. The interest rate is based on your creditworthiness.
Q. How to determine if you qualify to apply for a personal loan?
Many lenders outline the eligibility criteria required for loan approval on their websites. You can also use a personal loan eligibility calculator available on bank and financial institution websites, as well as on third-party financial services sites
Q. What are the benefits of applying for a personal loan online?
Applying for a personal loan online saves a significant amount of time and effort since you can do it from the comfort of your home. Some third-party financial services websites even offer paperless approval, eliminating the need to submit any paperwork to the lender for approval. Additionally, the online application process is completely secure.
Q. What documents do you need to provide when applying for a personal loan?
While the specific documents needed can vary among lenders, here are some common documents that most banks or financial institutions typically ask applicants to provide:
- Proof of identity
- Proof of address
- Proof of income
- Proof of business (for self-employed individuals)
- Any additional documents requested by the lender
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it’s all here, just a click away! Login Now!
Download The Mint News App to get Daily Market Updates.
Published: 08 Apr 2024, 12:31 PM IST