There’s nothing more convenient than having the cash you need to pay for large purchases. It’s the reason so many financial experts suggest putting money aside as early as you can in life. The goal to build up a reserve fund, approximately the equivalent of three to six months salary. That way, you’ll always have some cushion to handle sizable or unexpected expenses.
If you don’t have the necessary cash on hand to pay for big purchases, chances are you’ll probably charge the expense to your credit card and foot the bill later, perhaps over a period of several months.
While credit cards are wonderfully convenient, high interest rates mean they’re not always the smartest financial choice for borrowing money. In general, credit cards are best used for purchases you can pay off quickly, ideally as soon as the bill comes due. If your expense will take months or more to pay off, you’re probably better off taking out a personal loan instead.
Personal Loans – the Basics
Personal loans are a lot like car and student loans. They’re available from most banks, credit unions, and other lenders. A credit check is generally required before approval. Most personal loans are unsecured, meaning you don’t have to provide any collateral. As a result, interest rates tend to be a bit higher than on secured loans, such as car loans or mortgages.
The interest rate you’re offered will depend on the amount of money you need to borrow, and your credit history. Some personal loans have fixed interest rates, while others have variable rates that can rise or fall as the bank’s prime lending rate changes.
Once you’re approved for a personal loan, you’ll get the full amount up front. You’ll also have to follow a set repayment plan that requires you to pay off a small amount of the principal, plus interest, once or twice each month. The repayment term is usually between 24 and 60 months, but can be both shorter or longer. In some cases, borrowers aren’t penalized for paying their loan off early, creating the potential to save on interest by erasing debts ahead of schedule.
Credit Cards – the Basics
A credit card is essentially a portable, revolving line of credit, one you carry around inside your wallet. You have a monthly spending limit, say $5,000, and can use as much or as little of that amount as you wish each billing cycle, with the only requirement that you pay a minimum amount of the balance every month.
Of course, if you don’t pay the balance in full, you’ll probably have to pay interest on the remainder, sometimes at steep, double-digit rates. Once you repay any balance, it becomes credit again, and you can spend it. However, this can become a problematic temptation for those who struggle to rein in their purchasing habits and escape long-term debt.
Some high-end credit cards offer zero percent interest as an introductory teaser to new customers or allow you to transfer balances from other cards. If you’re offered the chance to carry a balance at no cost for up to a year or more, it can be a great way to save money on interest. Just make sure you use the time to come up with a workable repayment plan so you don’t end up paying punitive interest rates once your introductory offer expires.
Many customers also enjoy loyalty benefits from their credit cards, accumulating points through their spending that can be redeemed for travel and other rewards, or cardholder benefits such as free insurance or extended warranty protection.
How to choose between credit cards and personal loans
Introductory offers aside, personal loans are the best choice when you need to borrow more money than the monthly spending limit on your credit card. Unless you have the cash on hand to always pay your balance in full, personal loans also tend to be a better option for expenses smaller than your limit, because you’ll likely end up paying less interest.
The caveat, however, is the added cost of any fees or penalties associated with your loan. Make sure you read the fine print up front to avoid getting burned by costs that eat into the money you’re trying to save.