Credit Card or Loan? Pros and Cons
On occasion most of us need a little financial help. Whether that’s to buy a house, a car or other high-price item, at some point in our lives we’ll need to borrow some money. In this article we’re going to discuss the pros and cons of credit cards and loans.
Borrowing money needn’t be because we can’t afford something either.
Buying on a credit card can offer a level of protection from fraud or a business collapsing that we wouldn’t have otherwise. Anyone who has bought flights from Monarch recently will testify.
There are other reasons to borrow money that make perfect financial sense. If a large purchase will see you use all of your available cash, paying for the item with a credit card or loan means you can spread the payments over a longer period of time, protecting your cash.
It’s important to remind you that you should only ever borrow within your means to repay and that taking on any debt puts your finances under extra pressure, so financial discipline should be exercised at all times.
Assuming that you’ve looked at your finances and established that you can afford to borrow money, which is best – a credit card or loan?
A credit card is issued with a pre-agreed balance and interest rate. The borrower enters into a contract to repay a minimum fee every month but is allowed to pay extra should they wish to.
Most credit card agreements come with a lower introductory interest rate (many cards offer 0% interest rate at first), before the interest rate goes up to a higher rate, which is often as high as 29.9%. At this point, most borrowers then switch their balance to another card issuer with a 0% offer, keeping their repayments lower.
Every time you transfer a credit card balance, there is usually a fee attached, often around 3% of the outstanding balance.
Smart credit card borrowers will be able to borrow large sums of money and not pay any interest for the duration of their repayments.
Credit Card Pros
- Often cheaper – lots of companies offer a long-term 0% interest.
- Flexible repayments – you can pay extra back if you need to.
- Cash back – some companies offer incentives when you make purchases.
- Protection – credit cards offer more buyer protection than other forms of payment.
- Cash incentives – credit cards allow you to deposit money into your bank accounts as long as you have the balance available.
- Fast repayment allows you to quickly improve your credit score.
Credit Card Cons
- When the interest free payment is over, the interest is typically high.
- Credit limits are set by the issuer and sometimes may not be high enough for your requirements.
- Fees attached to balance transfers.
- Typically easy to acquire, so it’s easy to rack up a lot of debt.
A loan is where a bank or other financial institution will lend a given amount of money over a pre-determined period of time. The loan is typically paid back monthly at a fixed interest rate. Examples of loans include mortgages on houses, business loans or car finance.
There are typically two types of loan – secured, where the loan will be taken out against a valuable asset such as a house, or unsecured, where the loan isn’t taken out against an asset.
Loan decisions are usually made instantly (whereas credit cards may take a few days to be issued) and the money can be deposited in the borrowers account with seconds.
Given the fixed repayment schedules loans offer less in terms of repayment flexibility than credit cards, but that can help people with their financial planning as they will count it as another regular outgoing.
- Instant decisions usually made by your bank – you can have the money within seconds.
- Generally low interest repayments.
- Structured monthly repayments, allowing for easy financial planning.
- Lower settlement fee if you can repay the balance in full.
- Less admin – you don’t have to switch providers to keep interest payments down.
- Flexibility in terms of how long the loan is taken over – anywhere from 12 months to many years.
- Rigid repayments mean less flexibility to repay.
- Repayment structure means you still owe for a long time.
- Less ability to move money – it all arrives in one go, meaning you can’t deposit smaller amounts into your bank account.
- Negative history around PPI and other insurances.
It’s important to carefully consider your options when borrowing money. More than just the interest rate, consider your financial situation.
If you are likely to pick up large sums of cash such as bonuses or commission payments, a credit card may be a better option because you are able to pay more of the balance back quickly, reducing the time you spend owing money.
If you are going to need the money over a longer period, a loan may be a better option because the interest rate is fixed for the duration, as opposed to a credit card where the initial interest rate is only likely to be short term.
Both borrowing options have their benefits, but more important than anything is that you carefully consider your reasons for borrowing and pick the option that suits you and your requirements. If you don’t, it can lead to significant financial trouble.
For more borrowing advice, visit Moneysupermarket.com.