Credit Card vs Personal Loan – What to choose?

In an ideal world, we would all have enough cash to pay for all our needs. Since the world is not ideal, however, we more often end up needing to spend more than what we have. That is what the entire banking system is built on, of course – Credit, Interest and the need for money that drives the two.

Personal Loans versus Credit Cards

It is now common practice to assume that really big purchases like a house, a car and sometimes higher education will be financed by a Bank loan. This is not such a bad thing, after all, Banks offer loans for these expenses at relatively low interest rates.

The true difficulty arises when you need money for a purpose the Banks will not finance at such a low rate. A wedding expenditure, a holiday, maybe a purchase of white goods. That is where there a person is left with the option either of a personal loan or using his credit card to pay for the expenses.

Intuitively, it seems to make more sense to take a personal loan. After all, interest rates on personal loans vary from 13.5 to 17.5% at present, whereas borrowing on a credit card, as we have covered before, can go up to 29% interest on a per-annum basis.

Hold your horses, though. It is not as straightforward as that.

There are circumstances where it is actually beneficial to use your credit card as a tool to borrow.

1. When your borrowing is very short term

The issue with personal loan is that all the terms are set in stone when you take it. Pre-payments are generally not allowed. On the other hand, credit cards give a 30 day interest-free period. So if the reason you need to use borrowed funds is merely the gap between purchase date and the coming of your next salary, definitely prefer the credit card – and pay off the outstanding amount before the due date. This is literally free money! Why would you not take it?

2. When there are significant advantages of using the Credit Card

Credit card companies are more aggressive in pursuing alliances with other companies. So you will often find that there are cash-back offers for using Credit Cards to buy electronic goods, or freebies given for purchasing airline tickets. In such cases it is often beneficial to use your credit card to finance these expenses since the benefits outweigh the costs.

That said, when you know you will take more than a year to repay the amount, always go for a personal loan. Sometimes, for a major expense like a wedding or medical expense, it might make more sense to go for a personal loan since you anyway do not expect to be able to pay back the money in a month’s time.

In addition to that, a personal loan is broken down into EMI’s, which allows you to plan your expenses better, since it is, after all, a fixed monthly outgo, unlike a credit card outstanding which will add existing borrowing to fresh monthly borrowed amounts.

Another possible advantage of a personal loan is the scope for negotiation. While Credit Cards spell out the interest rate when you first sign up for it, at the time of taking the personal loan you can try and negotiate for a better rate of interest, especially if your CIBIL score is high.

The bottom-line, then, is clear. Opt for a credit card loan if and only if you expect to repay the entire amount in three months or less, or the expense is fairly small and is being offset by some other benefits.

For all else, the lower interest rate on a personal loan is a significant benefit, and should be your preferred option.

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Kunal is an ex-banker with a (largely self-proclaimed) flair for writing. He is an associate member of the Institute of Chartered Accountants of India and an MBA from Narsee Monjee Institute of Management Studies (NMIMS), Mumbai.

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