Money Management

5 Times When a Personal Loan is Better than Using Credit Cards

For many Americans the process of purchasing an item goes like this: find what you want to buy, put it on your credit card, and pay it off… eventually. As a result credit card debt in the United States is on track to reach $1 trillion by the end of this year. Meanwhile some consumers have given up on credit cards and instead turned to personal loans to either consolidate their debt or get the money they need to make big-ticket purchases in the first place.

Admittedly there was a time when getting a personal loan was an arduous and time-consuming process, leaving consumers more likely to just resort to plastic. However, thanks to FinTech companies and online lenders, getting a personal loan is not only easier but also a lot faster. With that in mind here’s a look at five times when getting a personal loan beats using credit cards:

When you’d need more than a couple of months to pay off your credit card

If you’re making a purchase with the intent of paying it off the next month when your bill comes due then using a credit card is perfectly fine and even encouraged. However if you’re looking at a purchase that will take you at least a few months to pay off it may make more sense to secure a personal loan instead. While credit cards may offer incentives such as cash back or airline miles that you may be tempted to take advantage of with a big purchase, the truth is that these rewards may be negated by the amount of money you’ll spend in interest.

Before deciding to make a big purchase (or really any purchase) on a credit card you should have a plan for paying it off. It may be unrealistic to pay off some items the following month but will you be able do it in three? Six? At that point you’re likely better off looking at a personal loan instead.

When your credit card carries a high interest rate

Unless you’re using a 0% interest introductory rate credit card chances are that it will carry a higher interest rate than a personal loan would. Of course your credit score will play an important part in what rate you’re able to obtain but typically personal loans will cost you less in the long run. In fact marketplace lender Lending Club reports that their personal loan customers save an average of 35% compared to what they’d spend using their credit cards. SuperMoney offers a convenient tool where potential borrowers can compare the multpile lenading options and decide whether applying for a loan might be best for them.

When your credit usage would be over 30%

The way your credit scores are calculated can get complicated. However one of the largest factors (second behind payment history) is your credit utilization. This refers to the ratio of money you owe compared to the amount of credit you have available. For example, if your credit card limit is $10,000 and you currently owe $2,000, you’re utilization would be 20%. To maintain good credit you’ll want to keep your utilization under 30%.

What’s interesting about credit utilization is that it only applies to what’s known as revolving credit. This is to say that credit cards, which offer an open line of funds that customers can access, are treated differently from mortgages, auto loans, and other debt types where the borrowed amount is predetermined. As a result you can avoid going over your 30% credit utilization threshold by getting a personal loan instead.

When you want to improve or diversify your credit

Speaking of your credit score, credit mix accounts for 10% to your FICO score. This means that you want to have a combination of revolving credit as well as installment loans, mortgages, etc. For that reason, if you don’t have a car payment, mortgage, or other form of loan currently in use, taking out a personal loan could actually help you improve your credit mix and potentially boost your score — assuming of course that you make your payments on-time.

When you want an easy budget

As mentioned earlier it’s essential to have a plan for paying it off large purchases before you commit to buying. In that respect personal loans make it easy to budget as your monthly payments are preset for you. However you should always look for personal loans that don’t carry any prepayment penalties. That way if you receive a raise, a bonus, or just feel like paying off your loan early you’ll be able to do so, saving you even more money on interest.

To Sum It Up

Credit cards can be great for earning free rewards, purchasing small items that you can pay off the following month, and — perhaps most importantly — for establishing credit. However, when it comes to making big-ticket purchases, they may not be the best option. In order to potentially save money, improve your credit score, and make paying off your item easier you may want to consider a personal loan the next time you’re faced with a large purchase.

Also published on Medium.

Other Articles by Jonathan Dyer