When you have a relatively large expense that you can't cover with cash on hand, you generally have two choices to consider: revolving debt such as a credit card, or installment debt such as a personal loan. Which option works best for you?
Consider the difference between the two types of debt. Revolving debt has no finite payment — you can pay as much or as little as you want, but realize that you are paying interest for the privilege of carrying that debt. Installment debt allows you to set up a regular repayment plan over time, and the terms of repayment (the interest rate and length of repayment period) will dictate how much you repay per installment and over the total course of the loan. You can budget your interest costs with certainty, assuming that you make regular payments.
Typically, credit cards come with higher interest rates than personal loans. Introductory offers on credit cards may make them the better choice for the first twelve to eighteen months, but once the introductory period has passed, rates rise dramatically. Personal loans tend to be preferred for larger expenses that will take you several years to pay off at your current income, and that are not easily combined with rewards programs (such as vacation expenses). The terms of credit cards and loans offered to you depend on your credit score. You can see your credit score and read your credit report for free within minutes with Credit Manager by MoneyTips.
Here are six examples where a personal loan may be the better choice for you.
- Business Startup – Given the uncertainty involved in a business startup, credit cards are an extremely risky way to fund your small business. You can tailor the terms of a personal loan to minimize your risk – and if you run into trouble finding acceptable loan terms, that says something about the risk of your business plan.
- Unexpected Health Care Expenses – Uncovered health care expenses can be large and collections from the medical field can be aggressive. You may prefer to take out a loan to pay off the medical expenses under more favorable terms.
- Debt Consolidation – It's possible to consolidate your debt within a credit card, but once the debt reaches a certain size, you will be unlikely to pay it off within the promotional period — and the post-introductory interest rate can be prohibitively large. Rod Griffin, Director of Public Education at Experian, notes that your credit score will not suffer with such a loan because all of the consolidated debts will be paid in full. However, there is a tradeoff to analyze. Griffin adds, "The tradeoff is you get a lower payment so you can manage those debts, but you pay it over a longer term so probably it will cost you more in the long term — another thing you have to consider."
- Weddings – It's your special day, and you will be sparing little expense. You will probably also be running into other new expenses as you and your spouse start your life together. By devoting your wedding expenses to a personal loan, it will be easier to help you budget and determine the best payback period for you given your other running expenses. "A loan can ease the financial stress of a wedding," said Kristin Shuff, a senior vice president at online lender LightStream. "Of course, it has to all align with a well-considered budget, but financing can put the cash you need right in your bank account to pay for the many expenses associated with a wedding … rings, gown, catering, flowers, music – even the honeymoon. An online application takes just minutes to complete, and couples can have funds as soon as the day they apply. That means you won't need to worry about paying expenses when they're due. And because we charge no fees, many couples spread their loan terms to make financing budget-friendly, or use gift money to pre-pay their loan balance."
- Dental Expenses – Dental insurance is not nearly as common as health insurance, making it more likely that your surprise dental expenses will not be covered. Braces and orthodontia can be incredibly expensive, especially if you have multiple children requiring dental work.
- Home Improvement – Because of the necessary planning involved, home improvement projects are well suited to personal loans. They require budgeting for materials and any contracting expenses, and the dollar values typically are large enough that credit cards may be impractical and/or generate expensive carrying costs. "We keep our pulse on the home improvement marketplace," continued Shuff. "The locked-in rates and speed of online personal loans are particularly appealing for homeowners looking to take on projects. We saw that people want to tackle larger renovations and live in their homes longer. So, we recently extended our home improvement terms to 144-months for loans over $25,000, allowing homeowners to budget lower monthly payments over a longer period of time; take advantage of the home equity that may accrue from their renovation; and pay their financing off early with no penalty should they decide to do so."
If your home has risen in value by 20-30%, you may want to consider a home equity line of credit (HELOC), a loan based on the equity of your home that allows you to draw out a maximum amount instead of a fixed amount. Let your planning account for these loans to take at least thirty days as they usually require paperwork and an appraisal.
We don't mean to suggest that a personal loan is always the best choice in the above situations, or that other expenses that people associate with credit cards should not be addressed with a personal loan. Make your decision based on a reasoned analysis of your situation. Compare the interest rates and repayment periods available to you given your credit score and total debt load, and then go with your best offer.
If you are interested in a personal loan, visit our curated list of top lenders.