There is always an ongoing debate between applying for a personal loan or a credit card to better manage one’s finances. There are many emergencies that compel us to make quick financial decisions in order to tackle the requirement at hand such as money to repair a car breakdown or paying off the outstanding amount on your credit cards. Dipping into your savings is a way out but only if you have savings in the first place. There are few questions that need to be answered before you decide how you are going to finance your financial emergency.
What is a personal loan? A personal loan is a loan that is issued by a bank, a credit union or any other financial institution for various personal reasons such as an upcoming wedding, paying off other debts or bills etc. They can be secured or unsecured loans. Secured personal loans require you to provide any valuable asset as a collateral or security against the loan such as a property you own, your car etc. Unsecured loans on the other hand do not have this requirement. If you defer on a secured loan, your lender has the authority to repossess the asset that you provided as collateral to recover their costs whereas unsecured loans are similar to a credit card where the borrowed amount is not backed by any financially valuable asset. However, as an unsecured loan is a much higher risk for the bank, the interest rates on such loans are much higher than secured loans. Though an unsecured personal loan seems to be less risky on your end, the bank still has the liberty to sue you to collect the debt you owe in case you fail to repay the entire loan amount.
Though an unsecured personal loan is similar to a credit card, there are some stark differences. To start, an unsecured personal loan has a definitive repayment period or a loan tenure by which you must repay the entire loan amount that comprises of the principal amount plus the interest. On the other hand a credit card offers you a credit limit up to which you can continue to borrow money as and when required having no definite repayment period after you have borrowed the money. You have the choice of either making minimum payments each month or paying the entire outstanding amount you owe.
Another difference between the two is that when you apply for a personal loan, the entire loan amount is disbursed to you at once whereas with a credit card, you can borrow little by little as and when you require money for specific reasons up to the available credit limit. The third significant difference is that personal loans have a much lower interest rate structure when compared to credit cards. Personal loan interest rates can be as low as below 5%, whereas the average interest rate for credit cards in Singapore is 25%.
An advantage of choosing a personal loan over a credit card is that you know exactly how much you need to pay each month and when you can successfully get out of this debt. With a credit card, however, many make the common mistake of only paying the minimum due each month that ultimately only snowballs the total debt and not decreases it. This is because apart from having a higher interest rate structure, the interest rate also compounds each time you fail to pay the outstanding amount, i.e. every time you pay only the minimum amount due, you are charged with an additional interest over and above the interest of the credit card. This mistake can take years to be corrected to get out of your credit card debt.
On the contrary, an advantage that credit cards have over personal loans is that you can pay off your credit card bill at your own pace according to your current financial situation and without compromising on your lifestyle whereas since personal loans have a fixed payment amount each month, this amount due can be on the higher end than what you can afford and if you fail to make the payments on time, you could end up paying late payment charges.
Ultimately if you decide that whether you will opt for a personal loan or a credit card, you will require the same amount of time to repay either loan, then it is advisable to opt for a personal loan over a credit card for the simple fact that the interest rate is far lower on a personal loan than a credit card which can help build your savings in the future.
Personal loans are ideal for a onetime expense during emergency situations. For example, if you need some immediate extra cash for your car repair or want to make some minor home improvements, a personal loan is a better option than borrowing from your credit card because they offer lower interest rates. But if your emergencies are frequenting and you need extra cash on a regular basis for varied reasons, then it does not make sense to apply for multiple personal loans, in that case you can rely on your credit card.
Another ideal reason to choose a personal loan is to consolidate multiple credit card debts and pay it off in one shot and save on the interest charged. Personal loans are great for debt consolidation and lowering the interest rate. One concern that you need to look out for before you sign the loan papers is if the loan has a prepayment penalty. A prepayment penalty is imposed when a loan is paid off sooner than the expiration of the loan tenure. Suppose after settling all your debts, you have enough money left to pay off the loan or have recently gotten a pay raise and want to pay off the loan, you need to check with your lender if there is any penalty to pay off the loan earlier.
To conclude, both personal loans as well as credit cards have their own advantages and disadvantages depending on the purpose of use. A credit card can come in handy to pay off a major expense when you are need of quick cash and a personal loan can help you bring your finances back on the right track.