If you have a big purchase or event coming up, you may need to look at funding options. Get started by understanding the differences between credit cards and loans.
The basics of borrowing
By borrowing money (also called 'opening a line of credit'), you can make a purchase now and pay it off bit by bit. Over time, you need to pay:
- the balance - the amount you originally borrowed
- any interest payable - an extra percentage charged every month or year
- any fees and charges that come with the line of credit
Two popular funding options are personal loans and credit cards. By understanding the features of each, you can choose the one that suits your situation. It's always important to make sure you can pay off the balance at a rate you can afford, while minimising the interest. It's also useful to know that any unsecured lending repayments of over 12 months duration will affect the amount you can borrow for a mortgage.
Credit cards and loans compared
Credit cards: a flexible line of credit
- Flexible borrowing - you can spend any amount up to a set limit
- Flexible repayments - at the end of the statement due payment you can pay off any amount, between the full balance and the compulsory minimum payment
- Introductory interest rates - there may be an interest-free period for purchases. Interest will be charged if you don't pay off your balance within this period
- Low limits - generally credit cards provide lower borrowing limits than may be available with personal loans, so any larger borrowing needs may be constrained
- A set amount - you can borrow the amount you need for a project or purchase
- A fixed term - you pay the money back in instalments over a set time (often several years)
- Predictable interest rate - if you opt for a fixed rate loan, your interest rate can be set at one rate for the entire repayment period
- High loan amounts - personal loans usually allow for larger borrowing needs than credit cards
When you might want to take a loan
Loans can be suitable for large amounts that will take a while to pay back.
Let's say you need to spend £7,000 - perhaps to get a new kitchen. You budget to pay back £1,000 per year and agree with your lender on how quickly you'll pay off the loan.
You'll pay interest, but it's usually lower than credit card interest. If you have problems with your repayment schedule, you may be able to talk to your bank and adjust your payments.
When you might want to take a credit card
Credit cards can be suitable lines of credit for smaller amounts you'll pay off quickly.
Let's say you need to spend £1,000 - perhaps on a big holiday. If you're confident you'll pay back £100 every month, you should pay off the debt within a year. If you opt for a credit card with 0% interest on purchases in the first 18 months, you'll pay no interest at all.
However, if you find yourself outside the 0% interest period you may have to pay some interest.
Your credit rating affects the rates and limits lenders offer you.