Pretty much everyone will end up borrowing a decent amount of money at some point in their lives. It could be for a vehicle, a wedding, or a once-in-a-lifetime vacation.
In most cases, the choices get narrowed down to either putting the expense on a credit card or taking out a loan. Once you’ve decided to pick one of these two options, the question becomes: which one will give me the best interest rate?
As with most financial questions, the answer isn’t exactly straightforward, but it’s not too hard to understand either. The interest rate you end up with could depend on your personal credit score or even the amount of money you’ll be borrowing.
There are quite a few factors to consider, but don’t worry – we’ll be going over the main points below.
1. The Interest Rates are Calculated Differently
With credit cards, the interest rate won’t ever change as time goes on just because the holder’s credit score improves or gets worse. The average interest rate for a credit card is currently about 16%, and there’s not really anything you can do to get a significantly better rate for a card.
As long as you pay your entire balance each month, you won’t be charged interest; but if part of last month’s balance carries over to the next month, you’ll have to pay interest on it. This happens whether the balance is $30, or $30,000 – and if it’s closer to the second number, you’ll be accumulating a whole lot of interest every month.
Loans work differently, in a way that gives you a chance of lower rates if you have a decent credit score. AmOne loans money at 3.99% to those with below-average credit.
In 2019, the average American’s credit score was around 700; this number should be good enough to secure an interest rate that’s significantly less than 16%. One thing to look out for, though, is the lender’s fees. For the really big loans, it might be as little as 1%, but it can go as high as 8% for small loans.
Given the fee structure of personal loans, they might not actually be the best choice for you if your credit score isn’t high enough. On the off-chance that the purchase you’re going to make can wait a while, one option is to take at least 6 months to improve your credit score. This could get you into an interest rate sweet spot, so you wouldn’t have to choose between two high rates.
2. A Credit Card can Take years to pay off, but Loans have end Dates
Part of the reason why some people villainize credit card debt is because it’s so easy to get into. A typical credit card requires the holder to pay an almost negligible minimum fee every month; you can keep using the card as long as you don’t go over the card limit, and as long as you keep paying the monthly minimum.
Meanwhile, that 16% interest is accumulating on the balance, so it’s increasing every month even if you aren’t spending anything. If you know what you’re getting into and can make sure that you’re paying it off at a reasonable pace, then putting a huge expense on your card isn’t the worst thing you could do.
The issue is, a lot of people don’t know this; they think that as long as they’re paying what they’re strictly required to, they’re still being responsible.
If you get a loan, on the other hand, you’ll be agreeing to pay off the total balance by a certain date. You’ll also have to commit to paying a certain amount every month; that’s a pretty big contrast to paying off a credit card, where you could pay whatever’s convenient if extra expenses pop up one month. On the plus side, this keeps you on a payment schedule that’ll prevent you from paying more interest fees than you’d initially counted on.
3. Getting a Loan Involves an Application Process, but you’ve already been Approved to Use your Credit Card
This is probably one of the reasons why a lot of people put huge expenses on their credit cards automatically and don’t even think about a loan. There’s no extra paperwork – their credit is already there, ready and waiting to be used. This leaves a lot of the accountability up to the user and works out well for the credit card companies when they get to charge interest on the ever-increasing balances.
If you want to get a loan, though, you’ll have to present various financial records to the lender so you can prove that you’re a safe bet. This is definitely more of a hassle than just charging something to your card, but you could potentially save thousands of dollars long-term.
4. What if you Care about More than Just Getting the Best Interest Rate?
It’s pretty important to figure out what strategy will give you the best interest rates, but that might not be the only deciding factor. Credit card companies get extremely competitive with the rewards they offer, and you might have already thought of all the fun stuff you could get up to with the rewards you’d get from that one big expense.
For some people, the rewards alone might make it worth the interest fees. For others, maybe flexibility in how much they pay each month is a priority.
If you wanted to get clever about it, one possible strategy would be to use your card for the expense – that way you can still get the card rewards – and get a loan to pay off the card. With this approach, you get as close as possible to having your financial cake and eating it too.
The way interest rates are calculated doesn’t change depending on your preferences, but the bird’s-eye view of your options is definitely subjective. You might not be able to change much about the interest rates you pay, but with the right information to help you make your decision, you can still feel like you’re calling the shots.