When a personal loan beats plastic
Sometimes the easiest way to pay isn't necessarily the smartest. Here are 3 times when taking out a loan makes more sense than using a credit card to pay a big bill.
This post comes from Gerri Detweiler at partner site Credit.com.
But that may not always be the best option. There are times when a personal loan trumps borrowing with a credit card. Here are three of them:
1. You don't want to risk your credit scores
Let’s say you need to borrow $4,000 to have dental work done. And let’s say you have a credit card with no balance and a $5,000 limit. If you charge the dentist’s bill, you will use 80% of your available credit on that credit card. When it comes to your credit scores, a high balance like that on a credit card is likely to hurt your scores.
The ratio of your balance to your available credit on a credit card is called the "utilization ratio." Consumers with the highest credit scores tend to use about 10% of their available credit.
But personal loans are viewed differently by many credit scoring models. If your loan is reported as "installment" rather than "revolving" credit, then utilization isn’t a factor.
2. You don't completely trust yourself
If you’ve ever run up a balance on a credit card with the intention of paying it off in full but found yourself making minimum payments instead, you know how easy it is to fall into the minimum payment trap.
Another temptation: you plan to charge a certain amount, but then find yourself adding to your balance when you run short of cash.
Instead, consider a personal loan with a set repayment period of three years or less. That way, you won’t be tempted to stretch out the debt indefinitely. (You’ll pay less in interest, as well.) To make it even easier, you can set it up so your payments come directly out of your checking account.
The Credit CARD Act, a federal law that was passed in 2009, did away with many credit card traps. For example, card issuers can’t raise the interest rate on your credit card balance at any time for any reason.
Credit cards can still end up costing more than you expected, though. Most cards carry variable interest rates that change when the interest rates they are pegged to (the "index") changes. The rate you see now may seem reasonable because interest rates in the economy are low. But when rates start to rise — and eventually they will — those variable-rate credit card rates will go up, and they may not seem so attractive.
By contrast, you can shop for a personal loan with a fixed interest rate. With a fixed-rate personal loan, your rate will stay the same until you pay it off. No surprises.
More from Credit.com:
- How to shop for a personal loan
- 5 things you should never put on a credit card
- The first thing to do before applying for a credit card
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