With Aussies currently in debt equal to about 150% of their household income, it’s no surprise that people are exploring different ways of paying it back. It usually comes down to two options; credit cards and personal loans. Both have pros, cons, penalties and fees, but choosing the way that best suits your financial situation could potentially save you thousands in interest repayments.
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The main points of difference
Personal loans and credit cards are both types of credit provided by financial institutions. They can be for similar amounts, but personal loans are for a finite amount of time, whereas credit cards are a revolving line of credit. Personal loans are usually available for terms of between one and seven years and you receive the entire loan amount at the beginning of the term. You then make ongoing payments to repay the loan in full.
Credit cards do not come with terms. You are offered a credit limit and required to make ongoing repayments to keep your account in good standing. You can continually draw up to and including that limit and spend however much you choose on your card. You need to repay a percentage of whatever you spend each month.
Structurally, credit cards and personal loans are similar. They are both forms of credit and they both require a monthly repayment. What differs are the features and fees. Credit cards offer interest-free days, balance transfers and rewards but personal loans are more suitable for debt consolidation and have a maximum loan term so the debt is always repaid. While annual fees are popular with credit cards, personal loans favour application and monthly services fees.
Comparison of personal loans and credit cards
- No ongoing fees
- Waived application fee for Orange Everyday cardholders
- No early repayment fee
100% confidential application
ING Personal Loan
The ING Personal Loan offers the stability of a fixed rate with flexible repayment options.
- Interest rate: 8.99% p.a.
- Comparison rate: 9.13% p.a.
- Interest rate type: Fixed
- Application fee: $100
- Minimum loan amount: $5,000
- Maximum loan amount: $30,000
Compare a range of personal loans
What to consider with a personal loan
- Lower interest rates than credit cards
- Repayment schedule means your debt comes with an end date
- Cheaper in the long term
- Not tempted to spend
- Minimum loan term means that you'll carry the debt for more than a year
- Can be inflexible (may charge for redraw options or not offer early repayments)
- Can take longer to apply for
- Large one-off purchases more than approximately $5,000 like renovations, holidays and cars
- Large debt consolidations
- Borrowing over a long period of time
Credit card points of consideration
- Immediate spending
- Can come with rewards
- Great option if you need a constant cash flow
- Balance transfer for debt consolidation
- Interest-free days
- Usually carry higher interest rates
- Only require a minimum repayment each statement period which means your debt can roll on and on
- Balance transfer rate reverts to the cash advance rate
- Smaller purchases less than approximately $5,000
- Small debt consolidations
- Short-term debts
- Everyday shopping or retail purchases to earn reward points
- Spending amounts that you can pay back within the introductory period
Personal loans vs. credit cards: What's the right product for you?
There is no single answer to this question. While a credit card might be the right choice in one situation, a personal loan might be more suitable in another, and in a third situation, neither might be appropriate. Here's how to decide what credit product will best meet your needs:
- What are you applying for the funds for? If you need money for an immediate, one-off expense, such as a large purchase, then a personal loan may be suitable. If you want continued access to credit, then a credit card may be more suitable. However, keep in mind that there are flexible personal loan and credit card products. For example, you can top-up some personal loans with additional funds, and you can also use credit cards to pay for one-off purchases, but as the loan term is ongoing you may be tempted to keep the repayments rolling over instead of paying it back in full.
- How do you manage your repayments? As mentioned in the point above, credit cards are an ongoing form of credit, while personal loans have an end-date. If either a personal loan or credit card will work for your needs, you may want to consider how disciplined you are with repayments. If you think you may be tempted with the credit line sitting there, then a more structured repayment schedule, such as that offered by a personal loan, may be worth considering.
- Are you consolidating debt? It's important to consider your options carefully. How much debt do you have and does it include loans and credit card accounts? Make sure you will be able to bring across all your accounts to consolidate – for instance, only certain providers allow you to balance transfer loans to a credit card. You also have the option of consolidating your credit card to a personal loan, which can help you save.
- How much are you looking to borrow? Credit card limits differ, as do personal loan limits. Generally, for an unsecured personal loan you cannot apply for more than $55,000. Secured personal loans are different but you will not be able to be approved for more than the asset you are using as security. You may be able to access a higher credit limit with a credit card but you will generally need to meet stricter eligibility criteria.
Things to consider when deciding between personal loans and credit cards
- Interest and comparison rates. If you compare interest rates, generally personal loans are cheaper. The true cost is reflected in the comparison rate as you need to consider any application or service fees. Since credit cards never display the comparison rate, it’s important to remember that you take into account the annual fee of the credit card.
- Fees. Personal loans usually have an application and service fee, whereas credit cards usually just have the annual fee, though you can find one without one.
- Your financial situation. If you have good control over your spending and you regularly follow your budget then a credit card could be suitable. Personal loans also can charge you early repayment fees, you will need to confirm whether this is the case with your lender. On the other hand, if you are slow at repaying debts, dragging it over the introductory period could incur high interest.
Matthew knows his financial situation
Matthew is looking to buy his first car and has found a 2000 model Mitsubishi Lancer selling at $5,000 at his local dealership. As this is not a private sale, he has a few different payment options. He wants to know if it's cheaper to pay for the car on his credit card and make extra repayments or apply for a personal loan with the same provider. As you can see from the table below, in the end it’s probably cheaper for him to purchase the car on his credit card, saving him up to $403.
|Feature||Personal loan||Credit card|
|Loan term||2.5 years||2.5 years|
|Interest rate||14.09% p.a.||12.99% p.a.|
|Interest plus fees||$1411||$1007.11|
Rates and figures correct as of 16/08/2013
Regardless of which you choose, you need to be disciplined in the way you use your credit card or personal loan and make regular repayments. With a credit card, always aim to pay back more than the minimum repayment to save on interest and if you have a personal loan, try to make extra repayments if you’re not penalised for it.