You might think that all forms of credit are the same but they all behave in different ways and are suitable for different circumstances and needs. If you understand what each type of credit is and how it works, it's easier to match the right sort to what you want to do.
The biggest forms of unsecured credit - i.e. those that aren't tied to a car or house - are personal loans and credit cards. It might be tempting to use both interchangeably but each have their benefits and drawbacks, and serve slightly different purposes.
When to Choose a Personal Loan
A personal loan is a lump sum that you borrow from a lender and it has a fixed repayment term that you pay back in identical monthly instalments. You can work out how big a loan you might be able to afford with a personal loan repayment calculator.
You want to fund a large purchase
You can usually borrow larger amounts for lower interest rates; this is one of the biggest differences when you compare a credit card versus personal loan. You can borrow anything - usually - from $5,000 to upwards of $50,000.
This could cover anything from a wedding to a vehicle purchase.
You want structured repayments
A loan agreement means you take out a fixed amount to be repaid in regular, consistent amounts either weekly, fortnightly or monthly.
Unless you've chosen variable rates, a personal loan typically features stable repayment amounts and you'll know exactly what you need to pay. This can make it easier to budget and plan for, knowing what's around the corner.
You want lower interest rates
Relative to credit cards, personal loans - especially those with good credit ratings - feature interest rates lower (even half!) the rate of those found on many credit cards. Many credit cards feature rates above 20% p.a. while many of the most competitive personal loans have interest rates of 10% p.a. or thereabouts.
Quick disbursement
Provided you've applied with all the necessary documentation, a provider could have funds in your account within a handful of hours to one business day.
A credit card application, on the other hand, could take a little longer. Yes, once you're approved you can swipe up to your credit limit, but that initial hurdle might be longer than you anticipated.
Looking to compare personal loans? Below are a range of offers in the market.
When Not to Get a Personal Loan
There are a few instances where getting a personal loan doesn't make sense, including:
For shopping
Personal loans are generally best suited to singular, large purchases - whether that's for a car or car repair, wedding, medical expense, education or travel. You probably don't want to get one to cover the year's groceries, for example.
You want flexibility
Once the funds are disbursed, it's hard to maintain a revolving limit unless you open a line of credit or apply for another personal loan. Having multiple personal loans on the go could reflect poorly on your credit history.
Further, with some loans you generally aren't rewarded for paying it off early. You might even face a fee to close the loan early.
You want additional perks and other rewards
Personal loans probably don't come with features like airport lounge access, points programs or other shopping bonuses. Once the funds are in your account it's your job to make the repayments on time - that's it.
For small or incidental amounts
It seems to be a feature in personal lending land that the lower the loan amount, the higher the rate could be. For small amounts of less than $5,000, the fees and interest rates could be sky high relative to the loan amount. You also are at risk of veering into payday loan territory, which can be predatory loans that see you owe more than the initial loan amount.
For the odd bill or expense amounting to a few hundred or a few thousand dollars, a credit card could be a better option for smoothing them over.
When to Choose a Credit Card
A credit card is a facility with a set amount of credit extended to you by a lender attached to a physical or digital card that you can use to shop in-store or online. You have to pay it all back over time, with interest if you don't pay off your statement in full.
Many cards offer interest-free periods on purchases, usually for up to 55 days; as long as you pay off the purchase within this time, you'll pay no interest on it
Most credit cards offer you extra protection on some types of purchases, as well as more fraud detection than debit cards.
For routine purchases
Your repayments are more flexible; you can pay the minimum balance each month or pay more to bring your balance down sooner.
If you're planning to pay off another credit card or two, then you could look for a balance transfer card with an interest-free period of at least several months. This can be a useful way to consolidate debt and have a bit of headroom to pay it off for a low fee, plus low or no interest.
If you favour flexibility
If you don't have a balance, you don't pay any interest. Some cards even come with no annual fee. This means it can sit in your wallet as a backup in case of emergencies - whether that's a burst water pipe in your house or the transmission dies in your car.
Further, as it's a revolving line of credit in card form, you can draw on it whenever you want, up to your credit limit.
You want to smooth your budget
Credit cards can be handy to work into the household budget. If you've got many expenses coming between paydays, you could put them on the credit card and pay them later. Provided you pay it off before your statement is due, you won't pay any interest.
If you're looking at a credit card to help you to spread the cost of a larger purchase, then look for a card with a sizeable interest free period, an ongoing low rate, or a low annual fee.
If you desire rewards and travel perks
Some cards offer a rewards program or cashback on your purchases, which can help to pay down your balance or get other benefits. Credit cards can also be a worthy travel companion and offer not only a way to pay, but travel insurance, airline lounge access and other perks.
When Not to Use a Credit Card
There are certain aspects of a credit card that make tapping the plastic fantastic not such a great idea.
You want to avoid spiralling interest
Many credit cards feature an interest rate of 20% p.a. or higher. Further, many providers have a very low minimum repayment. It can be tempting to just make the minimum, but this means it can take you many years to pay off the balance.
In addition, credit cards often feature cash advances , which is basically a way to withdraw cash. Cash advances often don't come with interest-free periods, meaning interest starts being calculated right away, at rates often higher than the purchase rate.
You have problems managing your money
Credit cards can be difficult to manage if you are an impulse shopper. Once you've got the card in your wallet, there's not much stopping you from spending up to the limit every month, which could be thousands of dollars.
As long as you meet the minimum repayment, your provider likely won't come knocking, which gives you an impressively long leash to rack up tens of thousands in debt.
By not making strides to pay your debt off, you could take years to pay it off. The below calculator demonstrates just how dire the debt spiral can become.
See Also: Credit Card Calculator
Statement periods can be confusing
Even for the financially informed, your credit card statement can be confusing. They often aren't explicit in saying 'If you do not pay X by Y date, you will face Z in interest'. Instead, they often just show the minimum amount payable, but you'll want to pay this off in-full to avoid interest.
If you get confused by numbers, this can give cause for a pause in putting a bunch of expenses on the credit card.
You want a big purchase
With credit cards, your limit might only be a few thousand dollars depending on your financial circumstances. Once you've demonstrated good handling, your limit can rise. This can make it hard to pay for stuff worth a lot more.
You desire structured debt and repayments
Other than the minimum repayment, you can rack up thousands on your card and not have any real structured, regular requirement to pay it back. On the other hand personal loans provide a regular, structured repayment method. Provided your interest rate doesn't change, your repayment will be the same.
You have a checkered credit history or irregular income
It can be hard to get approved for a credit card, especially one with a good limit and a low interest rate, if you have a poor credit history or you don't have regular, full-time wages.
Many credit cards demand a minimum income of $30,000 or so - more for premium credit cards.
You want fast cash
Once you've got the card, it's simple - you can tap or purchase up to your limit with no need for approval. However, getting the card in your wallet can take a bit of time - from getting approved, to setting up your account, to getting the physical card or digital wallet set up, it can all take a minimum of a few days.
Contrast this with a personal loan, which can be approved and funded within a day if you are prepared.
General tips when applying for a personal loan or credit card
Regardless of whether you decide on a credit card or personal loan - in which the decision is personal and depends on your purpose for the debt - there are a few home truths to increase your likelihood of being approved in a timely manner.
Be aged 18 or older
It's going to be nigh on impossible to enter into a debt agreement unless you're an adult. If you're under this age, you might be able to get a parent to co-sign a loan or add you as a cardholder, but this is another consideration.
Be an Australian citizen or permanent resident
Often the products with the best terms or lowest rates are for citizens and permanent residents. It's possible to get a loan as a visa holder - especially for skilled visas - but the array of products might be more limited.
Have reliable income and a job
It can be hard to qualify for many personal loans or credit cards if you're either self-employed or only work casual hours. Many lenders want to see you can service the debt, so this means having a steady income and strong track record of employment.
Have your identification ready
Applications often require 100 points of ID - whether that's a drivers licence or passport, plus a Medicare card or rates notice/electricity bill/phone bill. Have copies of these ready to go as you start your application to speed up the process.
Prepare your bank statements and financial information
Have a few bank statements demonstrating regular pay going in, plus records of other debts and liabilities, as well as other assets to demonstrate you are a trustworthy borrower. Again, it's helpful to get these together before you launch into the application.
First published in July 2019 by Sharvani Mehrish
Head Photos by SumUp and Jakub Zerdzicki on Unsplash
