Personal loans vs. credit cards
July 11, 2023 9 min read
Personal loans and credit cards are two ways to borrow money. And they share some things in common. But as you look closer at the details, you’ll see some important differences.
Learn more about how to compare personal loans and credit cards. By knowing how they work, you may be able to better decide which type of credit is right for you.
- Definitions vary, but personal loans often refer to a type of installment loan that gives the borrower an upfront lump sum that’s repaid on a fixed schedule. And once the loan is paid off, the account is closed.
- Credit cards are a type of revolving credit with a set credit limit. As a cardholder makes purchases with the card, their available credit goes down. And as they make payments, their available credit goes back up.
- Credit card accounts are open ended, meaning they don’t have a defined end date. As long as the account remains open and in good standing, the cardholder can continue to use it.
- When used responsibly, both personal loans and credit cards may be part of building credit.
What’s the difference between personal loans and credit cards?
There are a few key differences between personal loans and credit cards, including the type of debt, loan length, and whether they typically have a fixed or variable interest rate.
Type of debt
One of the biggest differences between personal loans and credit cards is how the debt works, because they are different types of credit.
Personal loans are examples of installment loans. They’re typically given to borrowers as a lump sum. The loan is then paid back on a fixed schedule, typically for the same amount each month.
Credit cards, on the other hand, are examples of revolving credit. A credit limit is set for the card, and as purchases are made, the available credit goes down. Then, as payments are made, the available credit is restored.
Another way debt can differ is whether it’s backed by collateral or not. Depending on the type of credit card and personal loan, the debt may be secured or unsecured.
Credit card accounts are open-ended, meaning they don’t have an end date. So as long as a credit card account is open and in good standing, it’s available to use.
Installment loans typically have a fixed length. Once the loan is paid off, the account is closed.
Fixed interest vs. variable interest
Credit card interest rates, or APRs, are usually variable. That means they can increase or decrease based on something called index rates. But the Consumer Financial Protection Bureau (CFPB) says there are other times when a credit card’s APR could change—even if it has a fixed APR. Cardholder agreements have more details about individual cards. The card’s issuer may also provide a notice before a change is made.
Personal loans are more likely to have fixed interest rates. That means the rate typically stays the same for the length of the loan. But it’s important to check the full details of any loan agreement to understand how interest works in that loan agreement.
How are personal loans and credit cards similar?
Personal loans and credit cards can typically be used to pay for just about anything, as long as a seller accepts that form of payment and the terms of the loan are followed.
There are also similarities during both application processes. If you’re applying for a credit card or personal loan, the lender may pull your credit. Lenders do this to measure creditworthiness, or your ability to repay what’s borrowed, according to the CFPB.
With both personal loans and credit cards, a higher credit score generally gives you a better chance at qualifying for and receiving a low interest rate. But there are still loans for people with no credit history.
When to consider a credit card
Credit cards may be a good option when you:
- Want to pay for everyday purchases. Credit cards are good for making day-to-day purchases such as groceries, gas and bills. But keep an eye on your balance, because some of your credit score is based on how much credit you use.
- Charge only what you can afford to pay off. If you pay off your balance in full and on time every month, the CFPB says you usually won’t have to pay interest on purchases. If you can’t pay off the balance, make sure you can at least make the minimum payment on time. You may be charged interest, but you’ll avoid that negative information on your credit reports and potential fees or penalties.
- Want a backup plan for emergency expenses. A credit card can help you cover unexpected expenses. But it could be a good idea to think about building an emergency fund, too.
- Want to take advantage of a low APR to consolidate debt. If you’re able to get approved for a card with a low or 0% introductory APR, it may be used to manage and consolidate debt.
Credit cards benefits and considerations
If a credit card is used responsibly, there are plenty of benefits.
- Credit cards give you the flexibility to pay down some or all of the balance—and then use it again as needed.
- You might be able to avoid paying interest if you pay off your balance each month before the due date.
- Some credit cards come with cash back and travel rewards.
There are also a few things to think about before you apply for a credit card.
- Some credit cards charge annual fees. Fees can be offset by the potential to earn bonuses or rewards, though.
- If you carry a balance, cards with variable interest rates may offer less predictable payments than fixed-rate loans.
- If used irresponsibly, your credit could be hurt and your debt could grow.
- If you need access to cash, there may be additional fees.
When to consider a personal loan
A personal loan could be a good option if you:
- Qualify for a loan with a predictable rate payment structure. Personal loans often come with fixed interest rates and monthly payments that are always the same. This predictability may make it easier to budget.
- Need to make a large, one-time purchase. Personal loans can be used to make these types of purchases that can then be paid off over time. People doing things like home renovations might consider personal loans.
- Need access to cash. If a personal loan doesn’t have spending restrictions, it may be helpful in emergency situations where cash is needed.
- Want to consolidate debt. Some people use personal loans to pay off and consolidate other debt. This might be a good option if you need several years to pay off the balance and if the interest rate on your loan is lower than the rate on your other debt.
Pros and cons of personal loans
The decision to apply for a personal loan depends on your needs and circumstances. But there are some potential benefits and disadvantages to consider.
Here are some possible benefits of responsible personal loan use:
- You may be able to access cash without paying fees.
- These may come with lower interest rates compared to credit cards.
- You can receive all the funds upfront.
Here are a few things to consider before applying for a personal loan:
- If you need more money after spending the funds, you’ll have to apply for a new personal loan, making it less flexible than credit cards.
- Some personal loans come with an origination fee or other costs, which could eat into the funds.
- If a personal loan is secured, it could carry extra risk of losing collateral.
How do personal loans and credit cards affect credit scores?
When you use credit cards and personal loans responsibly, by doing things like making on-time payments every month, they can help you build good credit. Here are some ways that credit cards and personal loans may impact your credit:
- Credit inquiries: Lenders and credit card issuers typically perform a hard inquiry when you apply to borrow money. This may temporarily lower your credit scores. The impact is usually minor, according to the CFPB. But the agency says applying for a lot of credit over a short period can give a bad impression.
- Payment history: When you make payments, your lender may report the activity to the credit bureaus. And, the CFPB says, making on-time payments every month is one factor that helps build credit. But the opposite is true, too. Late payments may hurt your credit scores.
- Credit utilization and mix: The amount of credit you have versus how much you use also plays a role in your credit health. The CFPB says having a mix of installment loans and revolving credit is also a factor in some credit-scoring models.
Want to learn more about your credit? You can get free copies of your credit reports from each of the three major credit bureaus—Equifax®, Experian® and TransUnion®—by visiting AnnualCreditReport.com.
You can also access your TransUnion credit report and VantageScore 3.0 credit score as often as you like with CreditWise from Capital One. It’s free for everyone, even if you’re not a Capital One cardholder. And using CreditWise won’t hurt your credit. And the CreditWise Simulator can help you see how certain actions—like opening a new credit card or applying for a personal loan—might affect your credit scores.
Other types of credit
Here are a few other types of credit that it may be helpful to know about:
- Home equity loan: A home equity loan is a type of installment loan that borrows against the existing equity you’ve built in your home. These loans can be used for things like home improvements, debt consolidation or other large expenses. They typically have a fixed interest rate, and the borrower receives a lump sum upfront.
- Home equity line of credit (HELOC): A HELOC also borrows against a home’s equity. But a HELOC is a type of revolving credit that typically has an adjustable interest rate.
- Cash-out refinance: A cash-out refinance lets the borrower take out a new loan that’s larger than the amount they owe on their existing mortgage. Then, the borrower gets the difference in cash.
- Cash advance: With a cash advance, cardholders can withdraw cash against their credit card limit. Cash advances often have a higher interest rate than normal credit card purchases. And they may come with additional fees. Other transactions may be considered cash advances, including using your credit card to transfer money to friends using apps such as PayPal, Venmo or MoneyGram, using your credit card to pay down debts like car loans, and exchanging dollars for foreign currency.
- Personal line of credit: A personal line of credit is another type of revolving credit that’s similar to a credit card. It can be used and paid down continuously up to your credit limit, as long as the account remains in good standing. They’re typically unsecured and may have variable interest rates.
Personal loans vs. credit cards in a nutshell
Before you apply for any type of credit, make sure to think about your financial goals and how you plan to use the credit.
If you decide a credit card is right for you, take some time to review their benefits and terms before applying. You can use Capital One’s credit card comparison tool to explore and compare different options at Capital One. See one you like? You can check whether you’re pre-approved for Capital One credit card offers—without hurting your credit scores.