Is it better to get a credit card or a personal loan?

If you’re weighing up whether a credit card or a personal loan is better for you, you’ll need to consider:

• The amount you’d like to borrow
• Interest rates 
• What you can afford to repay every month
• Whether or not you want a one-off lump sum amount
• How disciplined you are with money

Thinking about all of these will help you make the right decision for your circumstances. 

Credit card versus personal loan

Credit cards allow you to borrow money and spend it on multiple purchases up to a specific limit set by the lender. 

You have to make at least the minimum monthly repayments, but you can also choose to pay off more every month, or even the full amount you’ve borrowed. 

At the start of the following month, you can borrow up to the total amount agreed with your credit card provider all over again. This is known as ‘revolving’ credit.

Personal loans, on the other hand, lend money in a single lump sum. They’re usually used to spend on a one-off item or even to consolidate debt.

The loan is paid off in equal monthly instalments in a set amount of time known as the term of the loan. This is usually between one to five years. 

How do credit cards work?

Credit cards allow you to borrow money up to a set limit, which is a few thousand pounds for many people. 

Depending on your salary and credit history, limits can be much lower or higher, too.

You’re billed a minimum amount monthly, but you can choose to pay more.

If you pay back the total amount you’ve borrowed every month, you pay no interest. 

Pay back just part of the balance, and you’re charged interest on the remaining amount you owe. 

APRs (annual percentage rates) on credit cards can be around 20% or even higher, which is much higher than rates for the most competitive personal loans.

When is it better to borrow money with a credit card?

Credit cards are useful if you’re not sure how much you’ll want to borrow. 

They’re also handy for emergency payouts, like fixing your car if it breaks down or buying a new washing machine if that stops working.

Some credit cards offer 0% interest on purchases for an introductory period, typically between three and 21 months.  And of course, as long as  you repay in full at each bill, all credit cards have at least a month interest free.

Longer interest-free offers are  particularly helpful if you want to spread the cost of an expensive purchase, like a new television or a holiday.

But if you haven’t paid back the full amount by the time the 0% deal ends, you’ll probably be stung with higher interest rates. 

You’ll also need to have a good credit score to qualify for a 0% card.

Credit card pros 

• If you pay off what you owe in full every month, you don’t get charged interest. So it’s essentially free short-term borrowing. You can set up a direct debit to pay the full bill each month
• Introductory 0% APR offers also mean you can ‘borrow for free’ for a period. Just be sure you budget to pay back the debt before the offer ends. 
• Some credit cards offer reward incentives such as cashback, nectar and clubcard points plus travel perks like Avios points
• All credit card purchases on items over £100 (and under £30,000) are protected under section 75 of the Consumer Credit Act. So, if you’ve tried unsuccessfully to get a refund for faulty goods or services from a retailer or company (or if they go bust), you can make a claim against your credit card provider to get your money back
• Credit cards offer repayment flexibility. As long as you pay off the minimum amount monthly, you can choose to pay more or all of the amount without any penalty

Credit cards cons  

• There’s the definite risk of overspending. If you’re not particularly disciplined with your money and have been allocated a high spending limit by your card provider, you could rack up debt you can’t afford
• Paying just the small, minimum repayment every month means you’ll accrue high levels of interest and build up a larger debt that could take a very long time to pay off
• Credit cards typically charge much higher APRs than loans

How do personal loans work?

A personal loan is a lump sum which you pay back in monthly installments over an agreed term until the total amount is paid off. 

Interest is added, so you will pay back more than you borrowed.

The rate of interest on personal loans is typically lower than on credit cards and can be just a few percent.

When is it better to borrow money with a personal loan?

Most people use personal loans to pay for larger purchases such as a new kitchen or car, or to consolidate their debt into one single low-interest loan.

You can take out a personal loan for a few hundred pounds up to £35,000 or more. 

Interest rates typically fall the larger the loan you take out. For example, you might expect an average APR of around 7.5% on a £5,000 loan and 4.5% on a £10,000 loan. 

Interest rates vary hugely, though, and the rate you’re offered will also depend on your credit history. So it’s wise to shop around.

Personal loan pros  

• You can normally borrow more money with a loan than with a credit card and interest rates are typically lower.
• Fixed monthly payments make it easier to budget.

Personal loan cons  

• Less flexibility. If you’re short of money one month, you still need to make the full repayment.
• You may be charged an early repayment fee if you pay off the loan sooner than the terms agreed.
• Interest rates usually fall the more you borrow, so it can be tempting to take out a loan for more than you need. 
• Some loans offer variable interest rates, which can go up or down. So if you’re only just able to afford repayments when you take out the loan, you’ll struggle to pay if interest rates rise. 

Is personal loan debt better than credit card debt?

Both credit cards and loans – used in the right way – can boost your credit score. 

Make repayments on time and keep them up to date and you demonstrate that you’re financially responsible – which can boost your credit score. 

In the same way, late or missed payments can lower your credit score. Utilising all your credit can lower your score too. 

What's credit utilisation?

Credit utilisation refers to what percentage of the credit available to you that you're actually using.

For example, if you have a credit card limit of £1,000 and you spend £200 one month, your credit utilisation would be 20%.

Your total credit utilisation is the percentage across multiple cards. So say you have one credit card with a limit of £1,000 and another limited to £500, the total amount of credit you have available is £1,500. If you spend £750 across all of your cards, your total credit utilisation rate would be 50%.

Most lenders would prefer you keep the percentage to under 30% or, even better, less than 20% as using too much credit can negatively affect your credit score. But not utilising your credit at all doesn't help lenders see how responsible a borrower you are.

Credit utilisation only applies to "revolving credit" - which means borrowing methods that don't have a set end date. So personal loans and your mortgage (if you have one) wouldn't be included in your credit utilisation percentage, but they are factored in to your debt-to-income ratio - how much income you have versus how much you spend on repaying debt.

Is a credit card or a personal loan best for me?

It really is a case of ‘it depends’.

Personal loans are usually better if you want to borrow a larger, lump sum, while credit cards are convenient for regular borrowing. 

Both are useful to consolidate debt. 

Compare interest rates on credit cards and loans – but also remember that you may end up being offered higher rates than those advertised if you have a poor credit score. 

If you qualify for a 0% credit card which comes with a small balance transfer fee and a generous introductory period (say 21 months) this may be a better way of borrowing a fixed, smaller lump sum or consolidating debt of, say, £3,000. 

If you can clear the debt before the 0% interest offer ends, then you will definitely be better off. You may even be better off if you still have some of the debt left to repay when the interest rate on the credit card comes into force - even though it will be higher than the interest rate on a typical loan. 

It’s a case of doing the maths.

You also need to be realistic about what you can afford in monthly repayments and if you can be disciplined in sticking to your budget.