Personal loans or credit cards? To tell you the truth, there can't be an easy answer to this question. It all depends on the purpose of the loan and your objectives.
Since there's no definite answer to whether a credit card is better than a personal loan or vice versa, we're now going to look at a few real-life examples. This may help you decide which is better for your situation.
Maybe, you're planning to renovate your home and need a substantial amount of liquidity. While borrowing on your card is an available option, you may see that lenders are offering better deals on their personal loan products. If you calculate long-term costs, you might see that your savings are far greater with a loan.
But, does it make sense to get a personal loan for your everyday expenses? Probably not. More importantly, will a lender give you a term loan for small amounts? The answer may be in the negative because most lenders set a minimum borrowing amount on their loan. A card may offer more value and rewards for such expenses.
In the following section, we'll use certain parameters to compare a card and a loan.
Factors That Help Differentiate a Card From a Personal Loan
Here are some common factors that create perceptible differences between credit cards and personal loans:
What Is the Borrowing Limit?
In Singapore, for example, if your annual income is above S$30,000, you could usually borrow a maximum of 4x your monthly income through a personal loan.
However, on your card, the maximum borrowing amount will be subject to the predetermined credit limit. The credit limit will be determined by your lender. It could depend on your annual income, debt burden ratio, and credit score. Apart from that, if you're planning to take a cash advance (cash withdrawal) on your card, be warned that there could be a daily ATM cash withdrawal limit as well. The limit usually varies from lender to lender.
Why Do You Need to Borrow?
Are you looking to pay a utility bill, pay for your cab ride, purchase a plane ticket, or buy your grocery for the month? It goes without saying that a card can serve you better in such situations. Most cards will also offer you rewards in the form of cashback, cash rebate, reward points, or miles for such spends.
If you repay all your dues within the due date every month, you won't be charged any interest on your borrowing. That means that you're enjoying interest-free liquidity. Over and above that, you're receiving additional incentives in the form of various rewards. Hence, use your card to pay for small amounts.
However, if you need to borrow a substantial amount, a loan could be a better option. You'll have to pay low interest rates and you could even get a sign-up bonus. The best part is that you can stretch your payments up to 5 years or even 7 years in some cases (at least in Singapore). If you continue to pay your dues on time, you can pay back the loan on time and with lower interest charges.
What Are the Interest Charges?
In Singapore, the effective interest rate on term loans could be between 8% p.a. and 15% p.a. You may also have to pay a one-time processing fee when signing up for a loan.
Now compare this to a card. The finance charges for retail purchases are usually around 25% p.a. In case of a cash advance, it can shoot up to 28% p.a. or beyond. That's not all. On top of the finance charges, most card issuers will levy a cash advance fee of 6%, subject to a minimum of S$15 (on an average). This makes the cost of borrowing on a card extremely high, especially when compared to a loan.
Yes, some banks do offer interest-free instalment payment plans, which are ideal for big-ticket purchases. However, don't forget that the effective interest rate could still be higher than that on personal loans. Also, most 0% interest instalment payment plans come with a processing fee.
Take the My Preferred Plan from DBS Singapore, for example. It carries a one-time processing fee as high as 6% and the effective interest rate could be as high as 18.18% p.a.
What Are the Fees and Charges?
Some of the fees that apply to a card are annual fees (could be waived for a year or two, depending on the lender), processing fees, an over-limit fee, which could be around S$40, late payment charges, foreign currency exchange fees, if applicable, and cash advance fees.
In the case of a personal loan, the number of applicable fees could be less. Most banks don't charge an annual fee or offer a waiver for a few years. You may have to pay a late payment charge, an additional overdue interest, and early repayment fee, if applicable.
If you continue to service your personal loan account on time, you may have to worry about no fee apart from a one-time processing fee. Avoiding fees on a card could be relatively tougher.
What Is the Turnaround Speed?
In Singapore, even if the in-principle approval is on the same day for a loan, the loan disbursal could end up taking between 3 and 5 business days.
But, if you have a credit card, you can take a cash advance anytime you want. This means that there is hardly any waiting period. You can also use your card to make retail purchases whenever you want. So, you can continue to borrow up to your credit limit at one go or in multiple transactions. There is no need to make separate applications for separate transactions.
How Long Can You Stretch Your Repayment Period?
In general, instalment loans have tenures ranging from 1 year to 5 years (7 years in case of HSBC Personal Loan). In the case of lines of credit, there is usually no fixed tenure. However, you'll have to make a minimum monthly payment to roll the debt over to the next billing cycle just like a credit card.
For credit cards, the tenure for a purchase or a cash advance could be as long as the next billing due date. In Singapore, banks usually offer a billing period which could be between 20 days and 23 days, in general.
However, if we talk about purchase payment plans, the tenures could range from a few months to a year or two. The DBS My Preferred Payment Plan tenures can be between 3 months and 2 years.
Do You Need to Pledge a Collateral?
For cards, definitely not. Some lenders may ask for a collateral on loans. However, that's rare. It could only happen if you don't have a good credit score or don't meet one or more of the criteria.
Overdraft loan accounts could, however, be secured, which means that you'll have to pledge an asset. If you were to apply for the OCBC Secured Overdraft facility, you could pledge a fixed deposit or a unit trust investment account that you may be holding with the bank.
Are There Fixed Monthly Payments?
If you choose an instalment loan, you'll have to pay a predetermined, fixed instalment every month. The instalment amount would remain the same throughout the tenure unless you miss payments or don't make the full payment. In that case, additional charges may be imposed.
In the case of credit cards, there is no fixed monthly instalment unless it's a purchase-payment-plan related transaction. You'll have to make at least a minimum payment by the due date if you wish to avoid penalty charges.
The quantum of minimum payment could, however, be fixed. It varies from bank to bank. If you pay in full by the due date, you can avoid interest charges completely. In fact, paying off your card dues every month is one of the best financial practices to adopt.
How Is the Loan Amount Disbursed?
If you apply for a personal loan and your application is approved, money will be disbursed directly to the designated bank account. With cards, money gets deducted from your predetermined credit limit and gets transferred to the merchant account. Every time you pay off the dues, the credit limit gets restored to that extent, allowing you to use the credit again.
What Could Be the Impact on Your Credit Score?
In general, timely payments improve your score. Also, if your overall credit utilisation is low, it could leave a positive impact on your credit report. The only thing is that credit card debt can spiral out of hand faster than personal loans. Also, you can reborrow and add to your already standing balance. This can make cards a little riskier than loans.
Just remember one thing. If you service your loan accounts properly, you won't have to worry about your credit score. That's true for cards and personal loans.
Still Confused? Here's the Answer That You Have Been Looking for
Different experts could have different opinions. But, it all boils down to just two things. Your spending pattern and your expectation from the product. Do you need a standing credit facility to pay for expenses that you encounter on a regular basis? Or are you borrowing to take care of a one-time, big-ticket expense? A credit card could be an ideal choice in the first situation and a loan could be a better option in the second.
But, you have to consider one more thing. If you're confident that you can use a card effectively to manage your daily expenses and make timely payments, you could use it. Why? That's because almost all cards offer rewards in some form that instantly give you value for money.
A personal loan might be a better fit if you want to make small and predictable payments every month. Some could say that it's a safer option. Why? That's because you can't redraw even if you have made partial repayments. The size of the debt would remain the same unless you make too many defaults and attract higher interest charges and fees.
Debt on a card can get out of hand quickly, especially if you lack financial discipline. If you carry forward balances, you'll attract higher interests. If you falter on payments, you'll have to pay interest on the principal and interest/fees from previous cycles. Add to it the balances that you could accumulate from new spends. Sooner than later, it could turn into a perpetual, vicious cycle of debt.
All said and done, what we would say is this - take your time. Shop around for the best rates and deals. Analyse the various options that are available to you. You may be successful in choosing the right loan product for the right purpose.