Loans vs Credit Cards

There are so many options available to you if you need some extra cash, that finding the right deal can be confusing and even overwhelming.

When looking for additional funds, there are two main options people turn to – credit cards and personal loans.

For smaller purchases people often use credit cards. Credit cards have two great features:

• They’re so convenient – wallet and purse friendly, you can pay for items in store or online with ease. Provided of course that the purchase is less than the credit limit you have available (that means the amount the card company agreed to let you borrow, less any balance that you have on the card).
• Credit cards are also very flexible with repayments, you can pay the whole thing in one go, pay a minimum (usually 3% or 4% of the amount you owe) or anything in between. That means you can tailor the monthly payments to suit you.

Given cards are so flexible, why would you choose a personal loan? Often it comes down to the amount of money you need. If you’re planning a larger purchase, your credit limit might not be high enough to make the purchase on your card, or perhaps you’d rather not use most of that limit up in case of some unforeseen emergency.

It’s important to weigh up the pros and cons of both borrowing options. The following example shows it’s worth doing some number crunching beforehand.

Imagine you’ve got £3,000 of debt, you visit a comparison site like Experian and check what offers you’re eligible for. You may be presented with multiple offers for cards and loans and wonder which is the best option. Especially as many credit cards offer 0% interest for an initial period but all loans will carry an interest rate.

To try and simplify things, let’s compare a loan with a 9.9% interest rate over two years, and a credit card with 0% interest for two years. Looking at the loan, from the representative example you see that the total repayments are £3,305.09, so the total interest you are paying will be that minus the original loan amount of £3,000 i.e. £305.09.

Now, let’s look at the credit card. You see there is a 3% fee, so transferring £3,000 onto the card would cost £90 and, if you pay it off in the two years, there’s no interest – so that’s all you’ll pay. There will be a long-term interest rate, but that won’t apply if you pay it off in time.

The key thing to remember is – always clear the debt on your card before the 0% period ends.

If you don’t, the interest rate on your credit card will shoot up as soon as the 0% period is over. (Expect to pay anything from 18% to 40% interest, depending on the card).

The best way to make sure you don’t get stung by interest payments is to divide the balance on the card by the number of 0% months. For example:

• Card debt = £3,090 (£3,000 + £90 fee)
• 0% card period = 24 months
• Card debt divided by 24 months = £128.75
• Monthly payment needed to clear debt without paying interest = £128.75

So in this example, it looks as though the card is the better deal. The loan would cost you £305.09 in interest – but the card would only cost you £90 in fees. There would be no interest to pay (as long as you pay off the card balance within the two-year 0% period).

But bear in mind, if you continue to spend on your card then the interest charges could end up being much higher. There’s no exact formula for this – it can be quite complicated to calculate and keep on top of.

So, the answer to the question about which to use is “it depends”. Here’s a head to head comparison which might help:

Whichever option you choose, make sure that you are realistic with yourself about your ability to afford the repayments.