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Credit cards versus personal loans - which option is right for you?

Credit cards versus personal loans - which option is right for you?

There are many reasons why people choose to borrow money at some point in their lives. The two most common types, credit cards and personal loans, provide contrasting pros and cons which can be confusing due to the plethora of different options depending on your credit score, how much you wish to borrow and the period you have to repay it.

Whether you wish to treat yourself or a loved one, make improvements to your property or purchase a holiday or a new car, Wesleyan Bank has selected five top tips to help you decide whether a credit card or a personal loan is best for you depending on your financial situation.

Know how they work - credit cards are unsecured 'revolving' debts and allow you to borrow and spend up to an agreed limit. The annual percentage rate (APR), and the maximum amount of money you are entitled to, is decided by your financial provider based on your credit score and can range from a few hundred to several thousands of pounds.

With revolving credit, you have the option to either pay the balance off in full at the end of each billing cycle or to carry a balance over from month to month. Carrying a balance from one month to the next is referred to as 'revolving' the balance.

Credit cards require you to make a minimum monthly payment, typically around 1 to 3 % of the balance, and if you fail to pay off the full balance of your bill you will be charged interest which is often at a high rate. The amount of credit you have available depends on how much you spend and how much money you repay.

Personal loans can be secured or unsecured and are an 'instalment' of debt. You receive money in a lump sum, which is usually from £1,000 to £25,000 for a secured loan or typically £10,000 or more for a unsecured loan. A secured loan will often provide a lower interest rate than an unsecured loan, however this is because the loan is secured on your home, so you could lose your home if you cannot keep up your repayments.

Be wary of borrowing 'free' money - credit cards can be one of the most expensive forms of financing. But if you have a good credit score you may qualify for interest free promotions which can offer 0 % rates on purchases which make them an attractive option providing you pay off what you owe. A 0% rate is also frequently offered as an incentive for customers paying interest to transfer the debt to their own credit card.

As tempting as borrowing money for 'free' might be, if you fail to clear the balance or miss a repayment you could be forced on to a standard interest rate which can be from 18-20% APR.

To avoid expensive charges, make sure you can pay off the entire balance before the 0% rate introductory period expires.

Decide how much you wish to borrow - credit cards may be a good choice if you are looking to fund some short-term expenses (such as Christmas-related spend) and can pay off the debt and clear your balance within a certain timeframe. Some credit cards also allow you to transfer money directly into your current account at competitive interest rates.

Personal loans could be a better option though if you are looking to finance larger purchases over a longer period as you can often borrow more significant amounts compared to credit cards. Unlike credit cards, there is no way to avoid paying interest on a personal loan however in general the APR representative rates for personal loans are much lower when borrowing higher sums of money, typically if a loan up to £25,000 is required.

Avoid the minimum payment syndrome - monthly payments on credit cards are often set at very low levels. However, do be mindful that over time this option can become expensive if you only pay off the bare minimum monthly amount as it will take you far longer to clear your debt.

Personal loans may provide a greater degree of flexibility by allowing you to borrow larger amounts, for a fixed monthly repayment fee, giving you peace of mind as you can spread your repayments over several years and at the end of the period there will be nothing left to pay.

Review the rewards and hidden fees - credit cards offer vital protection for consumers in the event of something going wrong. This ensures that if you fail to receive the items you have paid for, or the supplier you have purchased them from goes into liquidation, your credit card provider should give you a full refund as they are jointly liable with the retailer. Reliable credit card borrowers can also earn rewards such as cash-back, cinema and restaurant vouchers or air miles.

If you can pay off your loan early, some financial providers will inflict penalty charges on you to do so which can be the equivalent of two or three months' interest. Make sure you read the fine print before committing to any financial agreement to avoid being subjected to hidden fees.

When applying for a credit card or a personal loan, know what you intend to purchase and decide whether you really need it to avoid borrowing money on the spur of the moment and spending more than you can sustain. Always be mindful of tempting offers and check the small print as the lowest rate is not always the best option.

If taking out a larger loan such as for making home improvements, it's important to consider how much value they will add to your property and whether the time and effort is disproportionate. You may also want to consider reviewing your home insurance cover when enhancing your home, either through the purchase of new items or increasing its overall value. 

'WESLEYAN’ is a trading name of the Wesleyan Group of companies.

Wesleyan Assurance Society and Wesleyan Bank Ltd are authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Wesleyan Financial Services Ltd, Wesleyan Unit Trust Managers Ltd, Practice Plan Ltd and DPAS Ltd are authorised and regulated by the Financial Conduct Authority.  Advice about investments, insurance and mortgages is provided by Wesleyan Financial Services Ltd.

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