Personal Loans Vs Credit Cards: Which Is The Better Way To Borrow?

When it comes to borrowing money, many of us automatically turn to a credit card to sort us out with what we need. But, should they always be our go-to, or are there other, better ways to borrow? In this guide, we’re putting both personal loans and credit cards through their paces, examining what we’ve found is important to people in the credit products they choose. Let’s see which one comes out on top.

How much you can borrow

How much you can borrow is the driving factor in many people’s decisions on what type of credit, and even which lender, to go with. While we never recommend borrowing more than you need, if a certain type of credit or a particular lender simply doesn’t stretch to that, it’s better to know up front. Let’s put credit cards and personal loans head-to-head.

Credit cards

The credit limit you’re offered with a credit card will largely depend upon your credit history, as well as the maximum limit on offer by the credit card provider you choose. According to figures by Uswitch, the average credit card limit in the UK is between £3,000 and £4,000. Some credit card providers will offer initial credit limits that are smaller than this – particularly if your credit history isn’t brilliant – and others may offer you a much higher credit limit if your credit history supports it.

Personal loans

The amount you can borrow as a personal loan, as with credit cards, depends on your credit history and how likely a lender believes you are to pay them back. Assuming your credit history isn’t holding you back, then you’ll usually find that personal loans range from £1,000 to £10,000 Some lenders can offer larger personal loans, up to £25,000, too.

So, which is better?

How much what you can borrow matters to you depends on what you plan to do with the money. If you’re looking to borrow purely to build credit, then you may not be so worried about getting an enormous amount of money. If you’re aiming to make a specific purchase, though, then borrowing enough to cover the cost is pretty important. On the whole, you can borrow more in one go with a personal loan than you can with a credit card, so personal loans win the first round!

Interest rates

On the flip side of the amount you can borrow is how much it’s going to cost you to borrow, also known as the interest rate you’ll be charged. It’s important to bear in mind not only the annual interest rate but also what that means in pounds and pence over the course of your borrowing – even low rates can result in a lot of money forked out over time!

Credit cards

According to MoneyFacts, the average credit card APR stands at around 25.5%. But many credit card providers offer 0% interest on both purchases and balance transfers for a fixed amount of time after you first get the card. You may still have to pay other fees, like balance transfer fees. What this does mean, though, is that if you clear the card’s balance completely by the time the 0% offer period ends, you could borrow with a credit card interest-free!

Let’s assume you don’t do that, though, and you end up paying interest on your credit card balance. Credit cards use an interest model called compound interest. You might have heard of this as “paying interest on interest”, which sums it up pretty well. Interest charges are added to your balance monthly, and each month as more interest is charged, it’s charged on your entire balance, including the interest previously charged – not just the amount you’ve spent on your card. Depending on the payments you make towards your credit card balance, this can mean the interest costs of your credit card quickly add up.

Personal loans

Again, according to MoneyFacts, the average personal loan interest rate currently stands at 7.4% APR. Loans don’t tend to come with 0% interest periods, so you’ll usually pay interest for the entire life of your loan.

Loans can charge interest two ways. With longer loans than you repay over a number of years, it’s not unusual for the interest on your loan to be charged as compound interest, the way credit cards charge interest. Or, you may find loans that charge “simple interest”, where interest is only charged on the money you originally borrowed. Which type of interest you’re charged should be explained in your loan agreement, or you can ask your lender. But, either way, it should add up to the annual interest rate you’ve been given.

So, which is better?

It really depends what you’re after! The 0% deals often available on credit cards make them a very appealing and cost-effective option if you’re certain you’ll be able to pay what you spend back before the end of the offer period, and won’t be tempted to spend more on the card. If you know you’ll need longer than any 0% credit card offer periods allow, though, then a loan may be the better option for you. Personal loans can come with average interest rates that are a fraction of the cost of a credit card. But, because they each have their advantages and drawbacks, we’re declaring this round a tie.

Speed

While the decision to borrow money is often well thought out and something you’ve planned for, when it comes to making the application, it’s because you’re ready to put your plans into action and you need that money now. Which way to borrow can help you better with that?

Credit cards

These days, you can apply for many credit cards and find out if you’ve been approved online, in minutes. Brilliant, right? Well, hold your horses. Even though you can apply and find out if you’ve been approved online, you’ll still normally need to wait until your physical card and PIN number arrive in the post before you can go shopping. Depending on the post, this can take up to ten working days.

Personal loans

Like credit cards, you can apply for many personal loans and find out if you’ve been approved online, with no paperwork to post. Then, if you’re approved the lender will send the money straight to your bank account. Many lenders say they can fund your loan the same day as it’s approved. Others sometimes need 2-3 working days for this, particularly if they need you to send in any extra documentation to support your application.

So, which is better?

Personal loans win this one, hands down. You can’t beat same-day funding, and although credit cards are making strides towards giving you access to your card virtually before it arrives in the post, most credit card companies aren’t quite there yet.

Flexibility

Sometimes, you might need to use credit to help you smooth out bumps in your cashflow. For example, many of us set when our bills are paid to align with when we get paid by our jobs. If you start a new job that pays you at a completely different point in the month, this could throw a real spanner in your system. Using credit could help you navigate it without an admin nightmare. But, which type of credit is better?

Credit cards

When you get a credit card, you’re assigned a credit limit that you can spend as much or as little of as you like. As you pay it back each month, that money becomes available for you to spend again if you need to. This cycle continues for as long as you have the credit card. Your access to your credit limit would only be restricted if you fell behind on your payments, started to regularly exceed your credit limit (which we don’t recommend doing – it incurs extra fees and can damage your credit history!), or closed your account.

Personal loans

When you borrow money in the form of a personal loan, you receive a cash lump sum that you will repay over a fixed period of time. If you find you need to borrow more while you’re still midway through repaying your loan, you will normally need to apply for another, new and separate loan. Lenders don’t usually allow you to “top up” an existing loan.

So, which is better?

While the fixed repayment term and predictable repayments are without doubt an advantage of a personal loan, the ability to dip in and out of your credit limit as you need it means credit cards are the winner in the flexibility stakes.

Your credit score

A big consideration for many people when borrowing money is how using credit will impact their credit score. But, is there any difference between the way loans and credit cards build or break down your credit score? Let’s find out.

Credit cards

When you first take out a credit card, the “hard search” of your credit report that comes with apply for it may cause your credit score to drop initially. But, as you start using and making monthly payments towards your card, your credit score will recover. And, as long as you keep making your monthly payments, stay well within your credit limit and, ideally keep your credit utilisation relatively low (below 30%), your score should keep going from strength to strength!

One particular way that credit cards can help build your credit score in the long run is by keeping them for a long time. Having accounts that you’ve held for a number of years is something lenders like to see as it indicates that you’re in a stable position and aren’t necessarily chopping and changing from one introductory offer to the next.  

Personal loans

Like credit cards, when you take out a loan, you’ll see a “hard search” on your credit report that’s linked to your application, and this can make your credit score drop initially. But, as you start repaying the loan and you clock up both a solid repayment history and start reducing the amount you owe, your score should recover and continue to grow.

Unlike credit cards, though, once your loan is repaid, the account is closed. There’s no option to keep the account for longer than your repayment term.

So, which is better?

Both ways to borrow can help you build your credit score if used sensibly and within your agreement with your lender. But, credit cards just have the edge on this one. That’s because you can, in theory, keep your credit card account forever and you can’t do this with a loan. Because lenders like to see that you have accounts you’ve kept for a number of years and only credit cards support this, they win this category.

Overall, which is the best way to borrow?

Personal loans and credit cards are both incredibly useful ways to borrow money when you need it. As you’ve read, they both have their own advantages and drawbacks that make them each well suited to some situations, but less ideal in others. Hopefully this guide has given you some food for thought, and next time you need to borrow, you’ll consider all your options rather than autopilot straight for a credit card.

To help you decide which is best for you at a glance, we’ve summed up the winner from each category we’ve discussed in one handy table: