Personal Loan Or Credit Cards: Which to Use & When?

You need money and you don’t have money.

And why do you need it?

Assuming its for genuine reasons like medical expenses, temporary disruption in your cashflows, urgent unplanned travelling, etc., what are your options then?

(Let’s skip borrowing money from family and friends for time being)

You borrow from lenders.

That is, you fund this via credit. If the amount isn’t huge, then you will most probably have to consider unsecured debt. These come in many forms. Most popular being personal loan and then comes the credit cards. There are others like P2P lending, etc. but they aren’t so mainstream as of now. So let’s keep our discussion limited to personal loans and credit cards.

And exactly what is personal loan? An unsecured personal loan is a loan that requires no collateral and can be availed for any purpose. These days, you can now easily get hassle-free unsecured personal loans from various types of lenders like public and private banks, NBFCs, etc. In fact, if you have observed (and I am sure you have), you are constantly being bombarded with tons of pre-approved loan offers just like that.

Credit cards are no doubt easier as they already have a pre-approved credit limit that you can use as a credit line. But even the unsecured personal loans can be your saviour when you require a loan in the form of cash for just about anything. In fact these days, with the advent of personal loan apps, it has become extremely easy to apply for personal loans online. Many of the lenders provide inbuilt personal loan EMI calculator in their apps to help loan borrowers estimate their loan EMIs. If you are interested in picking the right credit card for yourself, then do read How to choose the Best Credit Card in India?

So how do you go about choosing between the 2 options?

Here are some pointers to ponder over:

  • How urgent is your requirement? No doubt you can use credit cards You swipe your card and you get going. In the case of personal loans, It may be comparatively time-consuming. But new-age app-based lenders claim to handle it in few hours.
  • How much money you need? If your requirement is higher than your card limit, then you are obviously better off with personal loans. As you may get a get much higher amount (than credit card credit limit), depending upon your repayment ability.
  • What about Interest Rates – This is very important. The personal loan interest rates are much lower than credit cards. Depending on your credit score, the amount required and repayment ability, the rate of interest can range from 10% to 20% (read how credit card interest is calculated). And this is much lower than credit cards which can charge 30-40% per annum kind of interest rates. In personal loans, you have proportionate monthly EMIs that you need to pay regularly during the loan tenure (though you can still prepay with some penalty). In credit cards, you must make the full payment by the next due date. And that is something which may be difficult for most people if the amount required is high. If you are able to repay by the next month’s statement due date, then you will not have to pay any interest on the amount borrowed via credit card. However, if you are unable to pay your credit card bill in full by the due date, it can become a huge problem. You will be charged interest rate from the date of purchase itself. Just paying minimum amount due on credit card won’t help. Some cards do offer you to convert your credit card outstanding into personal loans with fixed EMIs.
  • Processing Fees – Some lenders might also charge a fee for processing the loan application. This fee is often equal to a few percentage points of the loan amount.
  • Prepayment Charges – If you already know that you need money only for a very short duration, then you will most probably be considering making prepayment soon. And no doubt paying a loan early can help you save money on the interest rate (here is an example of how prepaying home loan saves interest). However, some lenders charge a prepayment fee.

By the way, do note that some lenders may not be willing to give you unsecured loans if they are unable to determine your creditworthiness. So they will only offer you lower loan amounts or provide secured loans. These days and like in more maturing economies, its possible to get loans for people with bad credit as well. These obviously come with their own risk-mitigating and at times, stricter terms and conditions. But then you need to give it to the lenders as they are taking a risk by lending to people who do not have acceptable credit track records. And then, there is another option that is gaining popularity these days with people with no credit history: Credit Cards against Fixed Deposits.

That being said, for lenders to provide you with an unsecured loan without any collateral, they need to know your creditworthiness. Therefore, before you start applying for such unsecured loans, there are few things to understand. When you apply for personal loan, the lender would want to be confident about your repayment capacity. These lenders measure your repayment capacity based on various factors. They are as follows:

  • Credit Score: Your credit score or as it is also known as CIBIL score is a summary of your credit history. This score is an indicator of your timely payment of past debts. This score helps the lenders to predict how likely it is for you to repay the loan. A good credit score can also help you secure a low-interest rate and a higher loan amount as well.
  • Monthly Income: Lenders would want to know how much you earn monthly or annually to gauge whether or not you can repay the loan comfortably or not. They would also be interested in knowing how secure is your income and whether its plain salary based on fluctuating business income.
  • Debt-to-Income Ratio: The Debt-to-income ratio is a percentage of all your monthly debt payments divided by the gross monthly income. This is also one of the criteria that lenders measure to understand your repaying ability. Here, the gross monthly income is the one without any taxes deduction or any other type of deductions. The higher the ratio, the lesser chances of getting an unsecured loan and vice versa. In general, its assumed that 40-50% is the upper limit for this. Beyond that, its understood the borrower will have difficulties repaying the debts on time given his other expenses would also be there.

So what should you do?

The very first thing to ensure is to not take loans or credit card debt for unnecessary and discretionary things and if you are unable to pay for them immediately. Being reckless about spending just because you have easy access to credit can put you in debt spiral and in big financial problems (you need to understand what is your need vs. wants). Assuming the expense is genuine, necessary and must be incurred, and the choice must be made between a credit card and personal loans, the choice would depend on your cashflows, how quickly you need the money and the amount of money you need.

A credit card is better for smaller amounts that you can easily repay in a few weeks. But if the amount required is big and you can only repay it over the next few months or years, then taking a personal loan is advisable.

But it must be said that more and more young people are joining the workforce in India and there is an increase in digitization-assisted lending channels, there is an increasing trend among borrowers to opt for unsecured borrowings without hesitation. These unsecured loans or borrowing are loans given without collaterals and comprise personal loans, credit card borrowings, etc.

As a borrower, you should not be influenced by trends and only borrow when you genuinely need money. Remember, that because personal loans are unsecured loans, it means that these loans are not backed by any assets. And hence, rates will be high. So better to borrow only the minimum possible amount that you actually require and have the ability to repay quickly.

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