Bank loans and credit cards are two ways to borrow money, but they are very different products. A bank loan, also known as a personal loan, gives you a one-time lump sum of cash that is paid into your bank account. A credit card gives you access to continuous credit that is replenished each time you pay back the money you have spent.
Loans and credit cards both allow you to manage your money. But which one to choose?
Below we explain:
Bank loan: advantages and disadvantages
A bank loan gives you a set amount of money that you repay with fixed amounts over a set period of time.
There are two types of personal loans: secured and unsecured.
A secured loan usually involves large amounts and an asset will be used as collateral. The most common example is a mortgagewhere the bank can repossess your property in the event of default.
An unsecured loan does not require any collateral. The amount you can borrow usually ranges from £1,000 to £25,000, but less than £10,000 is most common.
A personal loan can be used for one-time purchases such as a new car or home improvements. Or it could be removed to consolidate miscellaneous, and more expensive, the debts you hold, making repayments easier and potentially reducing the interest bill.
Interest on a personal loan is a percentage of the amount you borrow. The rate varies from provider to provider and depending on your credit score, which can also determine if you are accepted for the loan.
The average interest rate on a loan of £5,000 is 7.1%, and for a loan of £7,500 to £10,000 it is around 4.4%. according to Moneyfacts data. In contrast, the average credit card interest rate is 23% per annum.
Learn more: Buy now, pay later vs. credit cards
Advantages and disadvantages of loans
|Fixed repayments, so you know clearly what you’ll pay each month||Lack of flexibility in reimbursements|
|Lower interest rates than credit cards generally apply||Sometimes you can repay the loan early, but sometimes not – it depends on the provider|
|You can borrow a larger amount at once than on a credit card||In case of prepayment of the loan, you may be charged a prepayment fee|
|It’s money that appears in your bank account, so there’s flexibility in how you spend it|
Learn more: How to do a financial detox
Credit card: pros and cons
A credit card allows you to pay for goods and services. This will give you a maximum borrowing amount – say £2,000 – and as long as you continue to make the monthly repayments, you can continue borrowing until you reach this limit.
With a credit card, you won’t receive any money, so you’ll have to pay for something at an outlet that accepts a credit card as payment.
The amount you can borrow with a credit card tends to be lower than with a personal loan.
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Advantages and disadvantages of credit cards
|Very small minimum redemption amounts – usually £5-£10 or 2-3%, whichever is greater||Interest rates generally higher than on a personal loan (on average 23% but ranging from around 19% to 40%)|
|Flexibility in the amount you repay||Small minimum repayments can make it easier to defer paying money back, and the interest charged can help debt skyrocket|
|It’s a line of credit that you have open – theoretically, indefinitely – rather than borrowing once||The credit limit, or the amount you can borrow, is usually lower than for a personal loan|
|When signing up for a new card, you can usually get a deal where you pay 0% interest for a fixed term||You are limited to spending money on goods and services that accept credit cards as payment. So there is less flexibility than getting money with a loan|
|If you repay in full each month, you can avoid paying interest|
|There is additional security when purchasing goods and services with a credit card, thanks to the chargeback system and Article 75 of the Consumer Credit Act|
|Some providers offer perks such as 0% balance transfer, commission-free foreign transactions, cash back, and loyalty points that can earn you cash back on your purchases.|
Can I use a loan or credit card to build my credit score?
Your credit score shows lenders how responsible you are with money.
The score is generated from your credit report, which lists loans and debts you’ve had in the past and whether you’ve met repayments.
When you apply for a loan or credit card, the provider will check your credit report.
The higher your credit score, the more likely you are to be accepted by a lender.
Having a lower score means your choice of providers may be limited and you are likely to pay a higher interest rate.
You can check your credit score with any of the credit agencies such as Experian and TransUnion.
Used correctly, a credit card or loan can help boost your credit score because it shows you can make regular payments on time.
But if you borrow money and are unable to meet monthly repayments, it can negatively impact your credit score.
Be aware that even a loan or credit card application will show up on your credit report.
Learn more: Does an overdraft affect your credit score?
If your application is rejected, it does not necessarily mean that your credit score will drop. But if you apply for several loans and credit cards in a short period of time, it may suggest that you are overworking yourself and may not be paying off your debts.
Many providers allow you to verify your eligibility for a credit card or loan before applying. This can reduce the chances of being rejected and having a detrimental effect on your credit score.
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So is it better to get a loan or a credit card?
Whether you take out a personal loan or a credit card depends on how you plan to spend the money.
If you rely on cash and like the idea of making fixed repayments over a set period of time, a loan would be more appropriate.
But a credit card might be better if you’re looking to borrow money on a more flexible basis and like the idea that your monthly repayments can vary.
Just make sure you pay at least the minimum amount each month.
Learn more: Should I take out a personal loan to build my credit rating?