First, here's a quick refresher:
Credit cards are a form of ‘revolving’ credit. This means you can borrow money up to a pre-determined limit, repay some or all of the debt, and then borrow the money again.
A personal loan is a more structured form of borrowing. You receive a cash lump sum and then repay it, plus interest, in equal instalments over a set period of time.
How do credit cards work?
A credit card lets you spend money you don't physically have. Your credit card provider will set a credit limit, which might be a few hundred or several thousands of pounds. This is the maximum you can borrow at any one time.
If you pay your bill in full each month you won’t be charged any interest on the money you have borrowed. If you don’t pay off the full balance, you’ll be charged interest.
A credit card’s APR (annual percentage rate) takes into account the card’s interest rate plus any fees and charges you have to pay upfront. Credit card APRs range from about 6% to 50%; the average card charges about 18%.
The APR and credit limit you’ll be offered will depend on how lenders view your credit score. You can check your credit score before applying for a credit card with ClearScore.
A good credit score is necessary if you want a credit card with an introductory offer of 0% interest on purchases. 0% purchase cards mean you can avoid paying interest on spending for a number of months.
Credit card repayments
Credit cards require you to pay at least the minimum repayment each month. This will normally be the greater of a percentage of your balance (e.g. 3%) or a cash amount (e.g. £5). Be careful: just paying the minimum each month will mean it will take a long time, and a large interest bill, to clear a debt.
You can set up a direct debit to pay the minimum repayment, a set amount, or the full bill each month.
How do loans work?
Personal loans can be used for large purchases, or to consolidate other debts. Loans are normally available from £1,000 up to £50,000 or more.
Lenders normally price loans in tiers. In general, the more you borrow, the lower the loan’s APR. APRs can be as high as 30% for loans of £1,000 but as low as 3.1% if you’re borrowing more than £7,500.
The APR and loan amount you’ll be offered will depend on how lenders view your credit score and report.
Unlike credit cards, there’s no way to avoid paying interest on a personal loan.
Personal loans have set monthly repayments over a period of time called the ‘term’. The longer the term, the more interest you’ll pay overall.
For example, if you borrowed £10,000 at 7% over three years you’d pay a total of £1,100 in interest. If you borrowed the same amount over 10 years, you’d pay £3,900 in interest.
When you take out a loan the lender will tell you how much you need to pay each month. You can set up a direct debit to make the payment.
It’s important to be confident you’ll be able to pay the required amount each month until the end of the term. If you miss a payment, you’ll be charged a penalty fee and the default could appear on your credit record.
You can pay off loans early but you may be charged an ‘early redemption penalty’ which is normally one or two months’ interest.
When is a credit card better than a loan?
Credit cards are better than loans for regular spending and borrowing smaller amounts. They are also a good option if you’re unsure how much money you need to borrow, or you need flexibility regarding repaying the debt.
Credit card purchases benefit from protection under section 75 of the Consumer Credit Act. If you buy something costing between £100 and £30,000, and pay for just part of it with a credit card, the credit card company becomes jointly liable with the retailer if anything goes wrong.
You can use credit cards abroad although you’ll be charged a higher interest rate and additional fees. But they are a good back-up in emergencies.
Some credit cards also offer reward points or cashback.
When is a personal loan better than a credit card?
A personal loan is better than a credit card if you need to borrow a large amount of money and can make regular repayments.
You can normally borrow more money with a loan than a credit card, and at a lower interest rate.
Providing you make all the repayments when due, your loan will be repaid at the end of the term. Loans instill discipline as, unlike credit cards, you can’t re-borrow the money you’ve repaid.