How to choose between personal loans and credit cards for urgent needs

Personal loan interest rates are much lower than credit cards.

If you have an urgent need for funds and don’t have any savings to dip into (and don’t want to borrow from family/friends), then you will need to look towards institutional lenders.

For the current generation, two of the most common options are credit cards and personal loans.

A personal loan is an unsecured loan that requires no collateral. These days, it is quite easy to get one if your credit score is respectable. Credit cards, on the other hand, give a pre-approved credit limit that you can use as and when you want.

So, say that you are short of funds for reasons like urgent travel, uninsured medical expenses, temporary income disruption, unexpectedly large repair or maintenance expenses, etc, then how do you go about choosing between a credit card and a personal loan?

Here are a few factors to keep in mind when deciding.

Urgency of requirement

This is about how urgently you need the money. If you need to pay instantly (say to book several urgent flight tickets for family members), then credit cards can come in handy. You can instantly use them to pay for the tickets. In such cases, you may not have the time to wait to get a personal loan.

Amount you need

This is important. Say your fund requirement is large (like Rs 3-4 lakh) and your credit card limit is less (say Rs 2 lakh), then you will have to go for a personal loan. But if your requirement is a small one and you are sure that you can clear it in a month or two, then using credit cards is better.

Difference in interest rates

This is the elephant in the room. And this is the major factor to decide. Personal loan interest rates are much lower than credit cards. The rates can range from 10 percent to 18 percent based on your credit score. While these seem high, you need to remember that credit cards charge 35-40 percent (and even more). So, as I mentioned earlier, if you need a small amount that you can pay back in full by the next due date, then a credit card is fine. But if the amount required is high and you know you will not be able to repay it in full by the due date of your credit card, then it can cost you a lot as credit cards will charge 3-4 percent every month. And don’t be under the impression that just paying the minimum amount due on credit cards is sufficient. It is not.

Then there are other smaller factors like processing fees, prepayment charges, etc.

Also, if for some reason you ended up using your credit card in the past and now have a large outstanding, it makes sense to consider taking a personal loan to clear off your credit card dues in one go. The reason is that the personal loan rates are much lower compared to the credit card rates and hence, your interest burden reduces. Plus, you get to have a set EMI that you can comfortably service over the chosen tenure.

Role of credit scores in personal loans

If you think you need to take a personal loan in future, then it is in your interest to ensure that your credit score is respectable. A good credit score can come in handy as it establishes your creditworthiness in front of lenders.

A good credit score not only makes you eligible to avail a bigger loan (if you ever need one) but also helps you get a lower rate of interest compared to someone who has a poor credit score.

Also read: Your credit score report: How to ensure accuracy and maintain a healthy credit profile

So, what should you do?

First, irrespective of whether it’s a credit card or a personal loan, never borrow to spend unnecessarily. Second, if you need to borrow, then your choice will depend on multiple factors. In my view, using a credit card is better for smaller amounts that you can easily repay in a few weeks (and before the due date). But if the amount required is large and you are quite sure that you will not be able to pay it back fully soon and need a few months or years to clear it, then taking a personal loan is advisable.