Credit card vs. Loan: which is the best option for me?

Picking the right way to borrow money can be a challenge, especially if you're not sure which option suits you best.

Think about how soon you need the money, the interest rates, and your spending habits. Just because one method suited you in the past, doesn’t mean it’s the right one for the situation you’re now in. 

Two popular options for borrowing are loans and credit cards. Each has its own advantages, depending on the circumstances. But which one is better for short-term borrowing? Let's explore the pros and cons of each to help you make an informed decision.

Should I go for a loan?

When deciding between a credit card vs. a loan, it's essential to understand how they both work.

Let’s take a look at loans first. Getting a loan involves borrowing a set amount of money over a fixed period. You will be offered a specific interest rate, and then a contract is drawn up where you have to pay a fixed amount back, usually monthly.

Secured loans are loans where you provide collateral (usually your home) to secure the loan. Because the lender has something to claim if you can't repay, they may offer lower interest rates, but there is a risk of losing your property if you miss payments.

Personal loans, on the other hand, are usually unsecured loans, meaning no collateral is required. These loans can be used for various purposes, such as home improvements, debt consolidation, or major purchases. Personal loans are often the fastest way of borrowing money.

Benefits of a loan compared to a credit card:

• The interest rate you’re offered may be lower than on a credit card, although this will depend on your credit rating.
• Because you pay a fixed amount each month, you can’t continue to rack up borrowing with loans. This makes you less likely to fall into persistent debt.
• You can usually borrow more with a loan than with a credit card if you need it for large purchases.

Pitfalls of borrowing via a loan:

• You have to pay a specific amount each month. This won’t change, compared to a credit card which will get lower as your debt reduces.
• Loans aren’t flexible once agreed – you borrow one lump sum at the start, and you can’t dip in and out of it like you can with a credit card.
• Loans can come with additional costs like arrangement fees or penalties for paying off early.

Or perhaps a credit card?

Credit cards are a form of revolving credit, which means you can borrow money up to a certain limit and repay it over time. You control how much you pay back each month, from the minimum payment right up to the full amount.

As you repay the outstanding balance, your available credit is topped up, allowing you to use it again. For this reason, credit cards are one of the most flexible forms of borrowing.

You can borrow however much you want within your agreed limit. Plus, you can pay as little or as much of it back at any time, as long as you meet the minimum repayments each month.

Benefits of borrowing with a credit card:

• You don’t get charged interest on your credit cards straight away. There’s a grace period (typically between 26-56 days) where you aren’t charged interest on your purchases.
• If you have a good credit rating, you may be offered an introductory offer for a set amount of time. This can mean little or no interest at all on purchases, cash transfers, or balance transfers (however, there may be a cash or balance transfer fee).
• It’s possible to borrow money on a credit card and never pay interest. To do this, you will need to clear the balance in full every month. Or pay off any transactions not covered by any introductory interest-free offers each month. Then pay the ones that are included before the offers expire.
• You just need to meet the minimum payment each month, but you can pay any amount back between that and the full balance.

Negatives of credit cards:

• If you don’t already own a credit card, it can take up to two weeks for it to arrive once your application has been successfully accepted, which slows down access to your money.

• Typically, credit cards have higher standard interest rates than loans. This will depend on your credit rating and the lender, however.

• If you miss a payment, you may lose any introductory offer rates you have been given. The lender may apply a late fee, and any missed payments will show on your credit report for 6 years.
• The flexibility can also tempt you to borrow more and pay back less. If you continue to pay back only the minimum amount each month, you run the risk of getting into persistent debt.

How is my credit rating impacted?

When it comes to your credit score, both loans and credit cards can help you build a positive history – as long as you make your repayments on time. But they do affect your credit file in slightly different ways:

• Existing credit cards won’t trigger a hard search. If you already have a card, borrowing on it won’t involve a new application – so there’s no short-term dip to your credit score.
• New applications will trigger a hard search. Whether it's a new loan or credit card, applying will usually mean a hard credit check, which may lower your score temporarily.
• Loans have fixed repayments. These regular outgoings can affect how lenders view your affordability, especially if your monthly income is stretched.
• Credit cards increase your available credit. A high overall credit limit could be seen as a risk by some lenders, depending on their criteria.
• Credit utilisation matters. This is how much of your credit card limit you’re using. Staying below 30% is ideal – anything above that can hurt your score.
• Loans don’t affect your utilisation rate. Unlike credit cards, loans aren’t included in your credit utilisation, which can be helpful for keeping that ratio low.

Alternatives to credit cards and loans

Credit cards and loans aren’t the only borrowing options available. Depending on what you need the money for, there may be a more suitable (or affordable) alternative:

• If you're struggling with debt: It might be worth speaking to a free debt advice charity like StepChange, National Debtline or Citizens Advice. They can help you look at your finances and come up with a plan — whether that’s a debt management plan (DMP), budgeting support, or other practical options.
• If you're looking to buy a car: Instead of using a credit card or personal loan, you could explore car finance options. These include hire purchase (HP), personal contract purchase (PCP), or leasing — all of which can spread the cost of a car in different ways, depending on your budget and plans.
• If you need a short-term buffer: An arranged overdraft might be worth considering. It’s typically more expensive than other borrowing options, but if you only need it for a few days and can pay it back quickly, it could work out cheaper than a payday loan or missing a bill payment.
• If you’re funding home improvements: A secured loan (also known as a homeowner loan) might offer lower interest rates than an unsecured loan or credit card, especially for larger sums. Just keep in mind your home is at risk if you can’t keep up with the repayments.
• If you’re building credit: A credit builder card might be a better fit. These are designed for people with little or poor credit history and come with lower limits and higher interest — but if used carefully, they can help improve your credit score over time. There are also a number of quick ways to build credit without a credit card.

Credit card vs. loan: Which should I go for?

The best option for you depends on the answers to three questions:

1. how much you need to borrow
2. how quickly you need the money
3. how soon you plan to pay it back.

Smaller amounts of money that you can pay back within up to six months are potentially better suited to credit cards, particularly if you own one already.

But if you need the money straight away, or if you need to borrow a larger amount, a loan may be a better option as they can provide instant funds. And whilst they are better for longer-term borrowing, depending on the interest rates you are offered, they may be cheaper over even a short-term period.

Ultimately, it boils down to your own circumstances. Understand whether flexibility is a good or bad thing for your financial habits and calculate how much interest you will pay over the time you aim to borrow the money for. And remember to weigh up the impact that each choice will have on your credit rating too.