When you have a relatively large expense that you can't cover with cash on hand, you generally have two choices to consider: revolving debt such as a credit card, or installment debt such as a personal loan. Which option works best for you?
Consider the difference between the two types of debt. Revolving debt has no finite payment — you can pay as much or as little as you want, but realize that you are paying interest for the privilege of carrying that debt. Installment debt allows you to set up a regular repayment plan over time, and the terms of repayment (the interest rate and length of repayment period) will dictate how much you repay per installment and over the total course of the loan. You can budget your interest costs with certainty, assuming that you make regular payments.
Typically, credit cards come with higher interest rates than personal loans. Introductory offers on credit cards may make them the better choice for the first 12 to 18 months, but once the introductory period has passed, rates rise dramatically. Personal loans tend to be preferred for larger expenses that will take you several years to pay off at your current income, and that are not easily combined with rewards programs (such as vacation expenses). The terms of credit cards and loans offered to you depend on your credit score.
Here are six examples where a personal loan may be the better choice for you.
1. Business startup
Given the uncertainty involved in a business startup, credit cards are an extremely risky way to fund your small business. You can tailor the terms of a personal loan to minimize your risk — and if you run into trouble finding acceptable loan terms, that says something about the risk of your business plan.
2. Unexpected health-care expenses
3. Debt consolidation
It's possible to consolidate your debt within a credit card, but once the debt reaches a certain size, you will be unlikely to pay it off within the promotional period — and the post-introductory interest rate can be prohibitively large. Rod Griffin, director of public education at Experian, notes that your credit score will not suffer with such a loan because all of the consolidated debts will be paid in full. However, there is a tradeoff to analyze. Griffin adds, "The tradeoff is you get a lower payment so you can manage those debts, but you pay it over a longer term so probably it will cost you more in the long term — another thing you have to consider."
It's your special day, and you will be sparing little expense. You will probably also be running into other new expenses as you and your spouse start your life together. By devoting your wedding expenses to a personal loan, it will be easier to help you budget and determine the best payback period for you given your other running expenses.
5. Dental expenses
Dental insurance is not nearly as common as health insurance, making it more likely that your surprise dental expenses will not be covered. Braces and orthodontia can be incredibly expensive, especially if you have multiple children requiring dental work.
6. Home improvement
Because of the necessary planning involved, home improvement projects are well suited to personal loans. They require budgeting for materials and any contracting expenses, and the dollar values typically are large enough that credit cards are impractical. You can also consider a home equity line of credit (HELOC), a loan based on the equity of your home that allows you to draw out a maximum amount instead of a fixed amount.
We don't mean to suggest that a personal loan is always the best choice in the above situations, or that other expenses that people associate with credit cards should not be addressed with a personal loan. Make your decision based on a reasoned analysis of your situation. Compare the interest rates and repayment periods available to you given your credit score and total debt load, and then go with your best offer.
This article was provided by our partners at MoneyTips.