Personal loans v credit cards: What's the best way to borrow?

By Emma Lunn

With loan rates at an all-time low, and the average credit card interest rate currently above 17.3%, is it better to take out a personal loan rather than a credit card?

Personal loan rates are falling, with Clydesdale and Yorkshire Banks recently announcing a best buy loan rate of just 5.1% APR for those borrowing between £7,500 and £15,000. Meanwhile, rivals Derbyshire Building Society and Sainsbury's Bank both offer loans at 5.4% APR based on a loan amount of £7,500.

How much you're borrowing, how you want to pay it off and your personal circumstances will dictate if a personal loan is right for you.

When credit cards make sense
Credit cards can be a good choice for borrowers who don't have a particular amount in mind when borrowing or want to have access to credit for emergencies. loans-v-credit-cards

Spending limits on credit cards can be as low as £500, although high earners with good credit scores may get limits as high as £20,000.

Credit card repayments are made on a flexible basis, with just a minimum amount due each month and no final date by which the debt must be paid off. This schedule can help borrowers with an irregular income or who want to repay differing amounts each month.

Many credit cards also come with introductory offers of 0% interest for a set period of time for either purchases or balance transfers. Used properly -- meaning the balance is paid off in full within the 0% interest time period -- these cards are the cheapest way to borrow money.

"The credit card route can work out much cheaper and is a better option for smaller amounts," says Andrew Hagger, founder of MoneyComms. "But you need to be disciplined enough to make all your repayments on time."

One possible consequence of a late payment is the termination of the promotional rate, leaving you paying the much higher go-to rate of interest, instead of the 0% rate that lured you in.

Another advantage of using a credit card instead of a personal loan is the extra layer of protection you get with plastic.

Under Section 75 of the Consumer Credit Act, the credit card company is jointly liable with the retailer if goods are lost, damaged or faulty -- meaning your card company will give you a refund if the seller will not. The protection applies to purchases costing between £100 and £30,000. Loans do not come with this type of protection.

In some cases, the interest rate charged on a credit card may be lower than that charged for a loan, especially if you want to borrow a small amount. This is because rates on loans tend to be much higher for small amounts (under £7,500) than on larger amounts.

When loans make sense
If you need to borrow more than £7,500, a personal loan can generally save you money compared with a credit card, assuming you have good enough credit to qualify for the best interest rates. With some of the cheapest loans boasting just over 5% APR, you're unlikely to find a credit card with an interest rate that even comes close.

Most personal loans come with a fixed repayment plan, so you pay the same amount each month for a set period of time. While that lacks the flexibility credit cards offer, a fixed payment can simplify your finances.

"The benefit of a loan is that it comes with a fixed interest rate and monthly repayment and should make your budgeting much easier, particularly if you're using it to pay a number of smaller debts," Hagger says. "It's simpler having just one standing order to deal with rather than trying to juggle three or four different credit card payments which have to be paid by different dates each month."

Personal loan amounts tend to be from £1,000 up to about £25,000, with interest rates higher on lower loan amounts.

In general, a personal loan is your best option if you want to borrow more than £7,500 and prefer (and can stick to) a set plan for paying off the debt.

The bottom line
Despite their differences, credit cards and personal loans come with similar responsibilities. Making late payments (or no payments at all) can harm your credit rating and make it more difficult to get either type of credit in the future. Conversely, making punctual payments can lift your credit rating, making it more likely you'll be able to pick and choose among all types of credit on the market.

See related: Credit cards vs. payday loans: What's the best way to get emergency cash?

Published: 4 February 2013