Personal Loan or Credit Card, Which Is a Better Option for You?

What is a Personal Loan?

A personal loan is an unsecured loan that does not require any collateral and can be availed with minimum documentation. It is an easy way to get funds to take care of various personal and financial needs and can be repaid according to the terms and conditions of the lender. Since a personal loan does not require any security, the banks and Non-Banking Financial Companies (NBFCs) only check your credit score, credit history, and income to analyse your repayment capacity while approving or rejecting your personal loan application. The rate of interest on a personal loan depends upon your repayment capacity and is generally very high compared to secured loans. It typically starts at 12% p.a. and can go up to as much as 28% p.a. Unlike many other loans, there is no end-use restriction on the funds availed through a personal loan. It can be used for your child's education or wedding, purchasing a vehicle, home renovation, purchasing a smartphone, medical emergency, vacation, clearing off other loans, or any other purpose.

What is a Credit Card?

A Credit Card is a type of plastic card issued by a bank or Non-Banking Financial Company (NBFC), which lets you borrow money from a pre-approved line of credit for the purchases of goods and services, balance transfers, cash advances, etc.

Both credit cards and debit cards look identical and carry unique 16-digit card numbers, but the key difference between them is that a debit card uses the money from your bank account (which you already have), whereas a credit card uses money from your pre-approved credit limit (which you actually do not have).

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There are two types of credit cards; Secured Credit Cards and Unsecured Credit Cards.

i. Secured Credit Card:

This type of credit card is primarily issued by banks against collateral, which is typically backed by a fixed deposit. This means the banks ask for a fixed deposit and provide you with a credit card with 80% to 85% of the fixed deposit amount. That said, if you make a fixed deposit of Rs 5,00,000, you will have a credit card limit of approximately Rs 4,00,000. Some banks offer a credit limit of 100% of the fixed deposit amount. However, banks generally have the minimum and maximum credit limits for secured credit cards, which may vary from card to card.

The bank does not hold any risk by issuing a secured credit card because it is backed by a fixed deposit. Your bank puts a lien on the fixed deposit linked to the credit card, which ensures that no one can withdraw the fixed deposit unless the bank removes the lien. So, in case you default on the credit card payment, the bank or the card issuer can recover the money from your fixed deposit to clear the dues. This type of credit card is ideal for you if you do not have a good credit score or do not fit into the income criteria of the unsecured credit cards.

ii. Unsecured Credit Card:

When it is about credit card, people generally refer to unsecured credit card. These cards are issued without any security deposit, and hence, the credit card issuers consider several factors while issuing them. Therefore, your income, credit score, credit history, etc. play an important role in the approval or rejection of your credit card application.

Apart from the basic difference of how you qualify for the card, both these types of cards offer similar benefits.

What are the similarities between a Personal Loan and a Credit Card?

Before diving into comparing personal loans and credit cards, it's crucial to understand the similarities between them. As we all know, the credit score plays a key role in approving or rejecting the credit. The credit bureaus analyse your credit repayments, credit defaults, credit inquiries, existing and past credit accounts, outstanding balance, etc. to calculate your credit history, based on which the lenders decide whether to approve or reject your loan application. Since personal loans and most credit cards are unsecured credits, your credit score is an integral part of the credit approval. Both of these options help you get instant access to cash during a financial emergency.

What are the differences between a Personal Loan and a Credit Card?

Here's how these two options differ from each other:

1. Purpose:

A Personal Loan can be availed for different purposes that might need huge money, such as a child's education, a child's wedding, home renovation, medical expenses, loan consolidation, etc. In contrast, a Credit Card is generally used for small or big purchases for personal or business requirements.

2. Process:

To avail of a personal loan, you need to apply with a bank or non-banking financial company with the necessary documents. The application can be done either online or offline and typically takes 10 minutes to 7 days to receive the funds, depending on the financial institutions' terms and your credit profile. However, if you already have a credit card, you simply need to swipe it at an offline store or provide the necessary details at an online store to avail the credit facility on your credit card.

3. Disbursement:

In the case of a Personal Loan, the amount is usually disbursed in a lump sum to the registered bank account of the borrower, which later can be used for any legal purpose. Whereas, in the case of a credit card, the borrower does not receive any amount in their bank account. The amount is directly transferred to the merchant on swipe or after proving the online details.

4. Repayment:

Personal loan is repaid in Equated Monthly Instalments (EMIs). The lenders usually insist on giving a standing instruction so that the EMI automatically gets deducted from the borrower's registered account on every due date. The credit card repayment is generally made in the next billing cycle on a due date predefined by the credit card issuer. However, based on your credit limit and previous transactions, the credit cards can offer to repay in EMIs.

5. Tenure:

A Personal Loan tenure could be anywhere from 1 year to 5 years. It can get extended up to 7 years in special cases. Some instant app loans of small amounts offer a loan tenure from 6 months to 24 months. A credit card usually offers an interest-free credit period of 30 to 45 days.

6. Interest:

The interest on a personal loan starts from 12% p.a. can go up to 28% p.a. Besides, the interest starts right from the day your loan gets disbursed. Whereas, credit cards offer an interest-free period of up to 45 days. However, if you are unable to repay the amount on the due date, the credit cards charge a huge interest on the outstanding amount. The interest rate on credit cards typically starts from 28% p.a. and can go up to 48% or even more!

7. Borrowing Limit:

The borrowing limit of the applicant is calculated every time the borrower applies for a personal loan. As discussed above, it depends upon various parameters like the borrower's credit score, income, repayment capacity, etc. Whereas, credit cards have a predefined credit limit on credit cards, which is set at the time of issuing the card. The borrower can use the credit card multiple times up to the credit limit.

So, when should you opt for a Personal Loan, and when to use a Credit Card?

Now that you know the difference between the two, you will be able to make an informed decision when choosing the one option. If you still have any doubts, here are some examples to clear them:

When to opt for a Personal Loan?

• When you need a large sum of money that is out of your credit card limit

• When you need to make a big purchase and pay in EMIs for a longer duration

• When the merchant does not accept credit cards, but you need to make that purchase on a credit

When to use your credit card?

When the purchase amount is smaller and within your credit card limit

When you are sure you can repay the amount before the due date

When your Personal Loan application might not get approved on time, and you need instant funds

To Conclude:

Although Personal Loans have relatively lower interest rates than Credit Cards, the loan amount has to be repaid over a set period of time. While credit cards provide ongoing access to funds and let you have an interest-free period, it could become too costly to repay the dues in a timely manner. It is advisable to use either facility only in case of emergency as it can become a financial burden to repay the huge EMIs. Besides, irrespective of the option you choose, your credit score is the key to getting approved at favourable terms.

Warm Regards,
Ketki Jadhav
Content Writer