We’ve all been there. We need to buy something but we don’t have the cash. And while your immediate reaction may be to charge it on your credit card, another option to consider is the more traditional, but often overlooked, personal loan.
As a financial planner, I often have clients come into the bank to apply for a credit card for the reward benefits, or a line of credit for the low interest rate. More often than not, however, people forget about the third financing option – the personal loan. Let’s take a look at three reasons why a personal loan may be a better option over a credit card, and two examples of when a personal loan just won’t do.
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Advantages of a personal loan
1. Fixed interest rates create stability. A personal loan gives you a lump sum of money up front, allowing you to pay it back over a fixed term – typically a period of one to five years. Loan rates are negotiable, which is a major advantage of choosing a personal loan over a credit card. Another advantage of a personal loan is that when the loan agreement is signed, the interest rate is fixed for the entire repayment period. This means that your interest rate cannot fluctuate and your payments will always remain fixed.
2. Fixed payments are easy to budget. Having fixed payments on your personal loan make sticking to a monthly budget a breeze. If you live on a fixed income, a personal loan may be a better option for you because the payments remain the same each and every month. With a personal loan, you don’t have to worry whether or not you’ll have enough money to make the minimum monthly payment like you would with a credit card, for example. Unlike credit cards, monthly payments on a personal loan don’t change.
3. The interest rate is lower than a credit card. Who wants to pay 19% on a credit card? Not me. A personal loan is a great financing option if you need a lump sum of money right away and you can afford to make payments to repay the loan over time. The interest rates on personal loans are substantially lower than the interest rates on credit cards. Interest rates on personal loans are also negotiable with your bank, whereas interest rates on credit cards are not. Bottom line? If it’s going to take you a few years to pay off the debt, go with a personal loan and you’ll save in interest.
When a personal loan just won’t do
If you want to enjoy travel benefits and earn rewards. Although personal loans are usually a cost efficient solution to your financial needs, they are not always the best option. If you are taking a vacation then using your credit card may be a better than applying for a personal loan because you can take advantage of the travel benefits. Upgrades, discounts and insurance coverage are all advantages that credit cards offer and personal loans do not.
Having said this, it’s important that you pay the balance – or as much of the balance as possible – when the bill comes due. Falling into credit card debt solely to pay for a vacation isn’t a good idea. However, if you spend what you can comfortably afford to pay off at the end of the month – credit cards are an excellent tool for earning extra rewards and travel perks on day to day purchases you’d typically make with cash. The key here is paying off the balance in full at the end of the month – you’ll avoid paying interest and earn rewards for purchases you would have made anyway.
When you need additional warranties and protection. If you are purchasing big ticket items such as appliances, furniture or electronics, then using your credit card may be a better option. Many credit cards offer an extended warranty in addition to the coverage that already comes with the product from the manufacturer. Very often department stores offer clients the option to purchase an additional warranty but it may not be necessary if you use your credit card to make the purchase.