If you are looking to fund a hobby or pay for an unexpected bill, you may be wondering the best way to borrow money.
There are a few different options you can choose from, including credit cards, personal loans and payday loans.
While loans and credit cards are two different types of credit lenders offer, they both require you to repay the sum borrowed with interest. Each has its advantages, such as helping boost your financial status and credit score if you keep up regular repayments.
Below, we take a closer look to help you compare your options and make the best decision for your situation.
Before you borrow
Before you hit the apply button, you’ll need to consider a few things:
- Why do you want or need to borrow money? – You should only borrow the amount you need, and some loan companies may ask what the money is planned for.
- What can you afford? – The original amount you borrow won’t be what you pay back. You will also have to pay any interest and fees on both loans and credit cards.
- You will need to make the payments monthly.
- Making too many applications for credit can impact on your credit score.
What is a credit card?
A credit card is a type of flexible loan from a card lender. It’s often used to pay for purchases where you may not have the available cash ready.
How it works:
- You receive credit from a lender, which you can then spend using their card.
- Each month you’ll receive a statement with what you’ve spent and what you still owe, along with a minimum payment due.
- You can repay in full at any time.
- If you don’t pay back the balance in full each month, the lender will add interest to the amount borrowed and you will need to pay the minimum amount each month.
Some lenders may offer an introductory interest-free time period, but once this is over, interest is added to the balance. You should aim to get the balance cleared as soon as possible to avoid adding on too much debt.
Pros of a credit card
- Ideal for smaller borrowing of up to £5,000, especially with 0% introductory rates available. Often comes with added cashback and rewards on purchases.
- All credit card purchases over £100 are covered by the Consumer Credit Act, providing you with extra protection should anything go wrong.
- You may be able to make money transfers into your current account at lower rates than a personal loan, which can be useful if you need the cash.
- Using a credit card wisely can benefit your credit rating and help your chances with larger financial applications, such as a mortgage.
Cons of a credit card
- The rate increases when introductory deals end, typically to around 19% APR and upwards, so aim to pay off the balance beforehand.
- If there is no fixed term and you are repaying the minimum amount each month, it can take longer to clear the credit card balance and cost more in interest.
- There is no guarantee you will get the deal advertised, as lenders use your credit history to set the interest rate, limit and introductory period. Each application goes on your credit file too, which could affect future borrowing.
What is a personal loan?
A personal loan is the short-term borrowing of a fixed amount of money from a bank or other lender, at a fixed rate of interest over a set term. It is often used to finance a new vehicle, a house renovation or consolidate debt, but can be used for any purpose.
How it works:
- You receive your loan in one lump sum.
- You pay back the loan in regular monthy instalments.
Pros of a personal loan
- Loans often let you borrow larger amounts than credit cards, making them ideal for big projects or purchases. They also tend to offer more competitive rates.
- When arranging a loan you can choose how long you want to take to repay the money you borrow, which can help you to manage repayments for a large sum over a number of years.
- Managing your debt is more straightforward, as you pay a fixed amount each month until the loan is paid back.
- Interest rates are generally lower for personal loans than credit cards, not including introductory deals.
Cons of a personal loan
- Interest rates can be higher if you are only borrowing a small amount.
- Lengthening the term can reduce monthly payments, but the longer the term is, the more interest you will have to pay.
- The rate you’re offered largely depends on your credit score.
What is a payday loan?
A payday loan is a short-term loan, usually for a small amount of money to cover unexpected or urgent payments. While these types of loans can be easy to get accepted for, they tend to come with a high interest rate – you can shop around to find the best rate.
Just like personal loans and credit cards, lenders will carry out credit checks to ensure you can pay back the loan.
How it works:
- You receive your loan as a lump sum.
- You’ll then pay back the amount – these loans are typically paid back within the month.
Pros of a payday loan
- Payday loans are quick and convenient, as you can apply quickly online. This is ideal if you need the money quickly to cover an essential cost – for example, replacing your boiler.
- You don’t need a high credit score to get approved.
- It’s an unsecured loan, so if you can’t make a payment, you don’t have any collateral against it.
Cons of a payday loan
- They can have high interest rates and can be incredibly expensive to pay off.
- They’re short-term only, which can impact your finances month to month.
- Some payday loans may require CPA (Continuous Payment Authority) before approval, which allows lenders to take payments from your bank account if there are sufficient funds.
Payday loan vs credit card vs loans – which is better?
If you’re looking to cover a one-time payment or urgent cost, payday loans can give you a small amount to replace a broken boiler or pay for unexpected car maintenance. Just make sure the repayment won’t affect your other financial commitments before you apply.
However, if you plan to borrow small amounts of money more regularly, then a credit card with an inviting 0% introductory rate could suit your situation. Regular full repayments can have a positive effect on your credit score, as you’re demonstrating responsible financial behaviour to lenders.
For larger amounts, a personal loan with lower interest rates and fixed terms would fit the bill. Bear in mind that, unless used wisely, the credit card and payday loans come with more risks – especially if you find yourself not being able to clear the full balance at the end of the month. In this case, the straightforward fixed terms of a personal loan provide peace of mind with a steady monthly repayment plan.
Depending on your circumstances and how you manage your money, you may find that one type of borrowing is more suitable for you. It is always best to do your research, compare your options and take a look at what is on offer before you decide to go forward with an application.
Looking for more advice on improving your credit score? Check out the full range of articles from our Know How hub.