Personal Loans vs. Credit Cards: What's the Best Way to Borrow for Big Purchases

How can you decide between using a personal loan or credit card for your big purchase? Here are a few key factors to consider to help you make your choice.

What interest rate will you pay?

Ideally, you want to make sure you pay the minimum interest possible on your purchase when you need to finance. If you can get a lower rate with a personal loan compared with a credit card, it often makes sense to do so.

Throughout life, there are lots of big purchases you’ll end up having to make. Ideally, you’ll have enough cash to pay for most of them outright. Unfortunately, life doesn’t work that way for most of us -- and borrowing for big things is sometimes a necessity.

Whenever you have something big you need to buy that you can’t afford to pay for, you may reach for your credit cards by default. Sometimes paying by credit card is indeed the right approach. But that’s not the case in every situation. A personal loan could be more affordable in some circumstances, so it’s important to consider both options when you decide which approach is right for you.

Personal loans usually charge much less than the standard interest rate on credit cards. However, if your credit is not very good, you may only be able to qualify for a high interest rate loan -- or for no personal loan at all. If you already have a credit card at 17% interest, your credit isn’t very good, and you can only qualify for a high interest loan at 20%, it makes little sense to take out the personal loan just to pay more.

There’s also another situation where a credit card could cost you less in interest: When you’re able to qualify for a special promotional APR. Some credit cards offer 0% interest on purchases for as long as 15 months. If you’re able to get one of those cards and will have the loan largely paid back by the time the promotional rate is up, using the card may be cheaper.

If you can qualify for a personal loan at a good rate because you have reasonably good credit and you don’t have -- and don’t want -- a 0% APR credit card, a personal loan should cost you less.

Most personal loan lenders allow you to shop around and compare rates without a hard inquiry on your credit report, so it doesn’t hurt you to try to find an affordable loan before just defaulting to putting your purchase on a card.

How much do you need to borrow?

The amount you need to borrow can also affect whether a personal loan or a credit card is the best approach.

Personal loan amounts usually range from around $2,000 to as much a $100,000 for well-qualified borrowers. If you only need to make a small purchase, such as a new $500 dishwasher, it may not make sense to get a personal loan if you’d have to borrow more than you need.

Credit cards, on the other hand, will give you a line of credit and you can charge as much or as little as you want, up to the maximum. If you need to make a relatively small purchase, you can do so. Unfortunately, in most cases, credit card companies won’t just extend you a $50,000 or $100,000 line of credit -- so you probably can’t borrow for really big purchases on your card.

Maxing out your credit card, or borrowing up to the credit limit, could also hurt your credit score because a maxed out card affects your credit utilization ratio. Credit utilization ratio -- or amount of available credit you’ve used -- is second only to payment history in importance when it comes to determining your credit score.

Rather than maxing out your card to pay for something costly, getting a personal loan could be a much better approach since now you’ll have a different kind of debt on your credit report that you’re paying back -- and lenders like to see you’ve had different types of credit.

How quickly do you need to make the purchase?

Sometimes you need to make a purchase right away. If that’s the case and you already have a credit card, you may decide to go out and buy the item that day. In this situation, you could always take out a personal loan later and use it to pay back the card if doing so would allow you to reduce your interest rate.

You wouldn’t be able to get same-day funding with a personal loan, as you could by using a card you already have. It often takes time to submit an application, have it processed, and receive your funds. With some lenders it takes a week or longer. While there are personal loan lenders out there who promise funds by the next business day, these quick loans usually carry higher interest rates.

Will the seller accept credit cards?

You’ll also need to consider whether it’s even possible to use a credit card for your purchase. In some cases merchants won’t accept them because of the fees they have to pay when they run the card. Or in some cases, merchants may charge you a processing fee if you pay with credit cards to help defray some of their costs.

If you can’t pay with a credit card, a personal loan is a good alternative because the lender deposits the funds in your bank account. You can pay by cash or check then, since you’ll have the money available to you.

This can also be helpful when dealing with merchants who offer cash discounts. You could take out a personal loan and use that to pay for your items instead of using a card so you could score that savings.

What’s your repayment timeline?

Finally, you need to consider how long you’re going to be paying back your purchase.

If you’re thinking about using a 0% APR card for 15 months, calculate out what your monthly payment would be to get the loan paid off by the time the promotional rate expires. If you can’t pay off the loan in full by that time, the interest rate will go up a lot. See how much interest you’d end up paying on the balance remaining and compare this to interest paid over the life of a personal loan.

Even if you aren’t using a card with a promotional rate that expires, considering your repayment timeline is still important. Most personal loans have either a three-year or five-year payoff schedule, although some can be repaid in as little as a year and some allow you to stretch out repayment for seven years or longer.

The big benefit of any personal loan, though, is that you’ll have a set payment schedule and know exactly when the debt will be paid off. This isn’t really the case with credit cards where your payoff timeline depends upon how much you decide to pay each month.

If you want to know exactly when you’ll be free of your debt burden, a personal loan is a better way to borrow than a credit card.

Is a credit card or personal loan best for you?

As you can see, lots of different factors go into determining whether it’s best to pay with a credit card or personal loan. Compare the total interest you’ll pay, how fast you need the funds, and whether the seller would prefer you to pay in cash before you decide that putting your purchase on your card is the right way to obtain big items that you need to finance.