It’s not always easy picking the right way to borrow. To make things a little easier, we’re running through the key differences between loans and credit cards. From how they work to their pros and cons, here’s how to decide which one is right for you.
How does a loan work?
When you take out a loan, you borrow a fixed amount of money for a defined purpose, for instance to buy a new car or consolidate your debts. You then pay it back in fixed monthly instalments, plus interest. At the end of your loan term, you’ll have paid back what you owe.
The total amount you need to pay back won’t increase during your loan term, but you will pay back more than you borrowed because of the interest charged. The APR you’re charged on your loan will be decided by the lender and is based on your credit history and personal circumstances.
How does a credit card work?
When you get a credit card, you can borrow as and when you need to. This is called revolving credit. When you first receive your card, you’ll have a balance of zero. If you spend using the credit card, the amount spent will be the amount you owe. If you then pay off the balance in full each month, you won’t pay any interest on your borrowing.
Top tip: look out for cards that give you longer than a month before interest is charged on purchases. These can be especially useful for spreading the cost of a bigger purchase without paying back more than the item cost.
However, if you only make the minimum monthly repayment, you’ll pay interest on the outstanding balance. This means that overtime, the amount you owe could increase and your monthly repayments could change.
The credit limit you are offered is determined by the lender and based on your credit history and personal circumstances. However, this can increase overtime if you are not automatically offered the maximum credit limit.
The pros and cons of taking out a loan
Taking out a personal loan can be great way to reach your goals and keep life moving. However, there are a few things to consider before you decide.
Pros of taking out a personal loan
- You can borrow large amounts
- You’ll have fixed monthly repayments, making it easier to manage your outgoings
- There are low rates available for low credit scores
- Making your repayments in full each month can improve your credit score
- You’ll have paid back what you owe at the end of your loan term
Cons of taking out a personal loan
- Missing a monthly repayment can negatively impact your credit score
- Some loans come with additional fees which can add up
- You’re committed to paying back your loan each month until the end of your loan term*
*Some loan agreements come with options such as loan payment holidays should your circumstances change. Make sure you know what options are available to you when you take out your loan.
The pros and cons of getting a credit card
Credit cards are a great way to improve your credit score and get credit confident. Yet, just as with a loan, it’s good to fully understand the pros and cons of this borrowing option.
Pros of getting a credit card
Using your credit card little and often and making at least the minimum monthly repayment will improve your credit score
- You’ll receive payment protection on your credit card spending
- You can borrow as and when you need to, keeping you in control
- You can take advantage of card specific promotions, such as:
Balance transfer promotions: this is where you can transfer an existing debt onto your credit card and receive 0% APR on that amount for balance transfer promotion window. (Note, transferring your balance sometimes includes a fee and you will be charged interest on the outstanding balance once the promotion ends.)
Purchases promotions: this usually involves receiving 0% APR on your purchases for a fixed promotion window. For instance, if the promotion window was 4 months, you wouldn’t be charged interest on your outstanding balance for 4 months. However, you would be charged interest on the remaining balance once the promotion ends.
- Some cards offer rewards points for spending
Cons of getting a credit card
- Not making at least the minimum monthly repayment can negatively impact your credit score
- If you don’t pay off your outstanding balance in full, you’ll be charged interest on the amount you roll-over to the next month, meaning what you owe could keep increasing
- You may receive a lower credit limit than you were expecting
Loans vs credit cards
Not all credit is the same. Personal loans and credit cards can come with a wide variety of features and terms. Here at Freedom, our mission is to ‘de-Baffle’ finance and you will always see these features and terms clearly set out so you can be sure there will be no nasty surprises later on.
Personal loans can have lower interest rates than credit cards but must be repaid over a set period of time. Credit cards provide ongoing access to funds and you only pay interest on outstanding balances that aren’t paid off in full that month, or when an introductory offer comes to an end. So, if you have an introductory offer, you can use it to your advantage to help you save. For instance, if your card has 0% APR on purchases for the first four months, you could spread the cost of a large purchase across the offer period and pay a little off each month, or save up and pay it off in one go before the offer ends.
Want to compare your loan and credit card options? Check your eligibility now without harming your credit score.