When you need to borrow money, you have the optional of taking out a personal loan or using a credit card. If you own a home, you may be able to open a line of credit on the equity of the house. Whether you take out a loan, use a credit card or open a line of credit depends on your needs and how you'll be able to repay the borrowed money.
Revolving vs. Fixed
Revolving loans include credit cards and lines of credit. Usually, you will have a limit on your credit card. You can borrow up to the limit at any given time or can choose not to use any of the credit line. With a credit card, you must repay at least a minimum amount each month. Fixed loans include personal, auto and home equity loans. With a fixed loan, you borrow a lump sum at one time. You then make regular monthly payments for a set amount of time, until the loan principal and interest are paid in full.
Interest Rates and Repayment
The interest rate on a loan is usually lower than that on a credit card. As of 2011, the average rate on a credit card was 14.41 percent, according to Bankrate, compared to 5.15 percent for an auto loan and 6.80 percent for a fixed student loan. Repaying a loan may prove easier than repaying a credit card, as you set an amount to repay each month and that amount should make the principal decrease. If you pay only the minimum due on a credit card, very little is applied to the principal each month, and it can take years and years to reach a balance of zero.
Line of Credit
If you own a home and want to make improvements to it or need to borrow money for another purpose, you have the option of opening a line of credit on the equity of the home. If your home's equity is worth $25,000, you can open a line of credit for that amount, but choose to borrow only $10,000 or $5,000 or whatever your current need is. You have a certain number of years during which you can borrow from your line of credit, then a certain number of years during which you must repay what you borrowed. You will pay interest only on the amount you end up borrowing, not on the initial amount of the credit line.
When to Use Credit Vs. When to Take Out a Loan
Whether you use a credit card or get a fixed loan depends on the size of the item you are purchasing and the interest rates available to you. For instance, if you need to borrow $1,000 to pay for a new stove, it's prudent to use a credit card only if you can pay it off at the end of the month or if you have a zero- or very low-interest-rate card, on which you will make regular, on-time payments until the $1,000 is paid off. If your card has a high interest rate and you won't be able to repay the amount in full by the due date, you should consider a fixed personal loan.
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