When looking out for a loan most people turn to either a personal loan or a credit card. Banks and other lenders today market these financial instruments extensively, painting a very positive picture of these credit instruments. However, personal loans and credit cards, each have their own pros and cons, and suit different types of borrowers differently.
How do Credit Cards Work?
Credit card is a form of revolving debt i.e. you can borrow month on month up to a certain credit limit and have to repay a certain minimum amount every month. Some credit cards also allow you to go beyond the credit limit, but that is detrimental to your financial health. It is an unsecured credit source, so, no collateral is required to avail a credit card.
Advantages of Credit Cards
- Credit cards are easy and fast to avail, they do not need any collateral backing and are often processed within a day.
- Being unsecured there is no danger of losing a collateral such as home or car.
- Many credit cards offer financial gains such as cash back offers and reward points up to 1-2% of what you spend using the card. Other benefits include free trip insurance when booking a trip with a travel credit card, diner cards for eating out on a discount and so on.
Disadvantages of Credit Cards
- The interest rate of credit cards is often in double digits, making it the most expensive financing option. This means if you do not pay up the entire outstanding every month, you end up high amounts as interest.
- The revolving nature of credit card may tempt you to overspend beyond your repayment capacity, or even overtake the credit limit. This is because even though you are paying interest on existing debt you still have the ability to make new purchases.
How do Personal Loans Work?
A personal loan is a form of fixed debt. It is an unsecured loan to be used for any purpose. Upon availing a loan, you receive the loan amount lump sum and, depending on the amount and the loan term, you make fixed monthly repayments to the lender. The term period generally varies between 2-5 years.
Advantages of Personal Loans
- A look at credit card interest versus loan interest shows that interest rates are relatively low for personal loans i.e. in the range of 10-20%.
- If you have a good credit rating personal loan amounts can extend quite high, up to even 15 lakhs. This can allow you to carry out essential expenses like home renovation.
Disadvantages of Personal Loans
- The application process for personal loans is more stringent, involving extensive documentation. You will have to submit your payslips, Form 16, bank statements and KYC documents. Disbursement may take up to a week.
- Most personal loans charge an origination fee which ranges between 1% to 5% of the loan amount. This is an extra expense compared to a credit card, which is often offered free of any pre-charges.
Personal Loans and Credit Cards: What to Avail When
A comparison of credit cards and personal loans shows that each applies well to different situations. It is upto the individual to select between personal loans and credit cards. If you need a large amount of loan exceeding Rs. 1 lakh and you are confident of repaying the monthly instalment in full, then a personal loan is the go-to option. Credit cards do not offer a credit limit as high as personal loans. However, if you require immediate credit for small expenses, credit card is the way to go. A number of credit card companies offer 0% interest introductory schemes on new credit cards. This is the best way to get a small interest free loan as long as you repay the debt in full before the introductory period expires.