Personal loans vs credit cards - 3 things you should consider

Posted May 2017

Do you need to borrow money? While cash might be the best way to pay, everyday expenses like utility bills and stubborn debt mean you can't always save money by investing in a term deposit or savings account to prepare for your next big purchase.

Maybe you want to buy a new car? Looking to reduce your debts? Or planning a big-ticket purchase? If you’re one of these many New Zealanders in need of a quick cash injection, a credit card or personal loan could be exactly what you’re looking for.

While loans and credit cards share similarities - they both let you borrow money, charge interest, and require that you pay that money back - they also differ in ways that can mean the difference between a manageable repayment and out-of-control debt. 

Today we're helping you make that decision easy by looking at the top 3 things you need to consider when deciding whether a loan or credit card makes the most sense for your next purchase, big or small.

1. The pitfalls of revolving vs fixed credit

A credit card is a relatively small line of permanent credit known as a ‘revolving credit’. As the name suggests, revolving credit works like a revolving door: your credit card’s set limit can be used to make purchases, and build up debt which you’ll need to pay back.

If you fail to make these payments before the due date, you then pay interest on this debt, while still being able to make new purchases. This ease-of-use and a lack of specified repayment terms can make credit cards a risky option. 

However, so long as you can make timely repayments a credit card offers extra flexibility in how much you spend and when you spend it, without having to reapply as you do with a loan.

A personal loan, on the other hand, is a ‘fixed credit’. That is, you’ll receive a fixed amount of money that you’re required to repay in set installments over the period of the loan.

Unlike a credit card, you can't increase the limit of a loan, or re-spend the amount you've already repaid. In this way, they provide peace of mind that you're spending within your limits, and not setting yourself up for unforeseen debts. 

2. The pro’s and con’s of unsecured or secured finance

Just because you’re eligible for a personal loan or credit card, doesn’t automatically entitle you to the best interest rate available. In fact, the rate you’ll pay on a personal loan or a credit card varies depending on your financial circumstances and whether the finance is secured or unsecured.

Personal loans usually offer a far lower interest rate than comparable credit cards, as they’re available in both secured and unsecured varieties. With a secured loan, you receive the lowest rate possible as it's ‘secured’ against a possession, such as a car. An unsecured loan, meanwhile, doesn’t require any form of security, but you’ll pay a higher rate of interest as a result.

By securing your finance, you could pay a much lower interest rate than even the cheapest credit cards, and save yourself a lot of money in the long run.

A credit card doesn’t offer this choice: it’s only ever an unsecured debt. As a result, you’ll pay a higher interest rate, but in return you'll have access to an interest-free period - generally between 30 to 60 days - where you can repay the balance without being charged interest.

Whether secured or unsecured, your credit score can also affect your personal loan or credit card rate. If you’ve checked this online and found that it’s low, don’t let this get you down as many banks and credit unions still offer loans to people with bad credit, as well as those who might struggle to get a credit card elsewhere like self-employed Kiwis.

You don’t need to live with a bad credit score either. There are a bunch of ways that you can work to improve your credit score before you apply for your next personal loan or credit card that will ensure you receive the best rate available.

3. Ease of use and the temptation to spend

When it comes to flashing the plastic, New Zealanders are big spenders. While you can easily budget for planned purchases, a credit card’s blessing is also its biggest curse: it's just so easy to use.

You might apply for a credit card for one reason - like a dream wedding, home renovation, or family holiday - but it’s all those little purchases that can quickly add up and before you know it, you’re carrying a growing credit card debt that’s weighing you down with crippling interest repayments.

As a personal loan is a fixed credit, it doesn't carry the same financially responsible pitfalls. You simply gather the required documents, apply for an amount, and then spend as you’ve planned. The only way to draw down more money is to apply for another loan, so you don’t need to worry about getting stuck in unforeseen debt. No stress, no worries!

How will you be financing your next purchase?

The choice of whether to fund your next purchase with a credit card or a personal loan is a very personal one, so it comes down to your financial situation and what you can afford to pay.

If you know you can pay off your purchases within a credit card’s interest-free period, then this might be the best way to finance short-term small or medium purchases. If not? Then you’ll end up paying a much higher interest rate than you need to.

In comparison, a personal loan remains the most affordable option if you’re wanting to finance a large or long-term purchase, consolidate your debts, or if you know you won’t be able to pay back any credit card purchases within the interest-free window.