When to use a personal loan over a credit card

Sometimes it's tough to know whether a credit card or a personal loan is the right choice for your current situation. While both options have their own pros and cons, usually a personal loan is a better solution.

Credit cards offer a revolving line of credit, which means you can access funds whenever you have available credit. Still, they often come with higher interest rates, and the monthly payments vary.

Personal loans offer a one-time lump sum of cash. Personal loans often offer lower interest rates, and most lenders offer fixed monthly payments. Some lenders will allow you to take out more than one personal loan at a time, but this depends on the lender's rules and your credit history. Those with bad credit may have more restrictions or may not get the lowest rates.

If you can't decide which option is best for you, here are a few situations when a personal loan is likely a better option than a credit card:

WHAT TO DO BEFORE APPLYING FOR A PERSONAL LOAN

Making an expensive purchase (like a car)

Unless you have a high credit limit with a super low interest rate, a personal loan is likely to offer better terms and more competitive rates. Personal loan amounts vary widely. You can use a loan to cover many expenses, including purchasing a car, medical expenses, home repairs or travel.

Expensive purchases can cost several thousand dollars. The loan rate could tack on hundreds more to your overall purchase cost, and your payment could change from month to month.

For example, let's assume you make a purchase for $5,000. Your credit card interest rate is 16% (a bit lower than average). If you make a monthly payment of $150 per month, it will take you about four years to pay off, and you'd pay an additional $1,657 in interest.

Now, let's say you opted for a personal loan for $5,000 at a 9% personal loan rate with a four-year repayment plan. You would still take four years to pay off the debt, but your loan payment would be $124, and you'd pay $972 in interest. The personal loan could save you $685 in interest.

Those with excellent credit or a better credit history will get the lowest rates. You can use a personal loan calculator to compare rates and find the best terms.

Debt consolidation

Personal loans are a great option when you need to consolidate several high-interest debts into one payment. Besides saving money on higher credit card rates, streamlining your monthly payments makes it much easier to budget.

Using a personal loan to consolidate debt can help improve your credit score by reducing your debt-to-income ratio. Further, on-time payments will also help boost your credit score. An additional benefit of consolidating debt with a personal loan is that you extend your loan repayment period. If you're struggling with loan repayment, consolidating debt can help lower your loan payments and extend how much time you have to repay what you owe.

Remember, if you use a personal loan to consolidate debt, don't start spending on your credit cards again. You could end up in a much worse financial situation without responsible spending.

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When you need fixed payments to fit your budget

Credit cards are convenient, but the monthly payment changes based on how much you owe and whether your interest rate has increased. If you want to live on a budget and knowing exactly how much you will pay each month is important to you, opting for a personal loan is your best bet.

When you take out a personal loan, your lender will likely offer you a set repayment term (typically one to five years). Your total loan, plus interest, is split over the total payments. This allows the lender to offer you a set payment each month.

HOW MUCH WILL YOU PAY FOR A $40,000 PERSONAL LOAN?

The bottom line

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