Personal Loans vs. Credit Cards: What's the Difference?

Personal loans and credit cards both offer a way to borrow money for any purpose you choose. While they share many of the same features, there are also some important differences, such as what they cost and how they need to be repaid. Here is how the two compare.

Getting Approved for a Personal Loan or Credit Card

Banks, credit card companies, and other lenders will look at a number of factors when deciding whether to approve you for credit. Your credit score is among the most important ones. It is based on your past credit history, including your record of on-time payments, how much debt already have outstanding, and whether you've ever defaulted on a loan.

The three major U.S. credit bureaus—Equifax, Experian, and TransUnion—compile credit reports on individual borrowers, which are then used to calculate their credit scores.

Credit reports do not include any information about your income, so lenders will typically ask you about that separately in your loan or credit card application. They may use it to calculate your debt-to-income ratio (DTI), which can be another important factor in their decision.

Personal Loans

With a personal loan, lenders provide you with a lump sum of money that you repay over time, typically with fixed monthly payments. This is known as an installment loan. A personal loan will have a fixed term as well, often of a few years, but sometimes longer or shorter.

Personal loans do not offer ongoing access to funds like a credit card does, but they usually have lower interest rates, especially for borrowers with a good to high credit score.

A personal loan can be used for any purpose. For example, you can use it to buy new appliances, consolidate credit card debt, repair or upgrade your home, or pay for a vacation. Personal loans are typically unsecured, meaning they are not backed by collateral. Secured personal loans can be available, as well.

Personal loans often charge an origination fee and may have other fees as well. This can add to their total cost.

How Do People Use Personal Loans?

In 2023, Investopedia commissioned a national survey of 962 U.S. adults who had taken out a personal loan to learn how they used their loan proceeds or might use a loan in the future. Debt consolidation was the most common reason people borrowed money, followed by home improvements and other large expenditures.

Credit Cards

Instead of a lump sum of cash, credit cards offer revolving credit, providing borrowers with ongoing access to funds that they can draw on as needed, up to an agreed-upon credit limit. As they charge purchases to their card, their available credit goes down. As they repay, it goes up again. This can go on indefinitely.

Unlike a personal loan, with a credit card, you pay interest only on the funds you use. And if your credit card has a grace period, as cards typically do for new purchases (but not cash advances), you can avoid paying any interest at all if you pay your balance in full each month.

Also, unlike personal loans, where your monthly payment is usually the same over the entire repayment period, your credit card bill can vary each month depending on any new charges and any leftover balance from previous months. You will be expected to make at least a minimum payment each month, but if that's all you pay, your balance can grow quickly, accruing interest all the while.

Many credit cards offer benefits like cash rewards or a 0% introductory period. However, if you run a balance, they typically have much higher interest rates than personal loans. And some have monthly or annual fees.

Other Types of Credit for Consumers

Personal loans and credit cards are just two ways to borrow money if you need to. Here are some alternatives that may be more appropriate in some situations:

• Home equity loans and home equity lines of credit (HELOCs). If you own a home with sufficient equity accumulated in it, you may be eligible for a home equity loan or HELOC. The first comes in the form of a lump sum loan, the second as a credit line that you can draw on as needed. Both tend to have relatively low interest rates, but because you're putting your home up as collateral, you could lose it if you're unable to repay.
• Personal lines of credit. A personal line of credit offers revolving credit like a credit card. You can access funds at any time as long as you don't exceed your credit limit.
• Payday alternative loans (PALs). Traditional payday loans are small, short-term loans with very high interest rates. They are often considered a form of predatory lending and are outlawed in a number of states. Some banks and credit unions now offer what they call payday alternative loans, typically in amounts of $200 to $1,000, with more reasonable rates.
  
  

Frequently Asked Questions (FAQs)

The Bottom Line

Both personal loans and credit cards make it relatively easy to borrow money when you need it—and to get into credit trouble if you aren't able to repay what you owe. In deciding between the two, you'll want to compare their interest rates, fees, and other details. Whichever you opt for, be sure to shop around, as lenders' terms can vary, even for the very same financial products.