Have you been thinking about committing to a big purchase, but you aren’t sure about the best way to pay for it? Going into debt isn’t always a terrible idea, but there are a few things you should know before you get past the point of no return. Even if you know that you’ll be able to take care of the balance eventually, interest rates could eat your lunch; you could end up being responsible for thousands of dollars more than you’d originally planned for.
There are some situations in which using a credit card makes more sense, and others where getting a loan is the obvious choice. You won’t necessarily need to choose one or the other every time you’re making a large purchase; as long as you’ve done a little homework beforehand, you’ll be able to make an informed decision.
When to use a credit card
There’s a reason why credit card companies offer rewards – it gives their customers a reason to pay for expenses on credit, instead of using a debit card or cash. If you’ve got a big purchase coming up, then you’ve probably already thought about the rewards you’ll get if you put it on your card. Just how big is this expense, though? Is it the kind of thing that you can pay off in a few months, or will it take years?
Remember, if it sounds too good to be true, it probably is. Credit cards are set up so that you can charge anything within your credit limit, as long as you keep making the monthly minimum payments. These monthly payments are so low that you could take years to pay off the balance, even if you never charged another cent on that card. In addition to letting you keep that debt for as long as you want, the card company would also be charging you interest on the balance, somewhere around 16%. Assuming the balance on your card is a pretty hefty one, this means that even consistent monthly payments will be just a drop in the bucket compared to the accumulating interest.
That was the bad news – now let’s take a look at the good news. There are definitely some strategies that will let you take advantage of a credit card’s flexibility, you just have to be smart about it.
If you really want to put a big expense on a credit card, then you’ll want a card that offers 0% interest for a period of at least a year, preferably 18 months. This choice alone should save you thousands in interest fees, plus you don’t have to keep up with a strict payment schedule. As long as you make sure that you’ve paid off the bulk of the balance by the time the interest charges begin, there’s really no significant drawback.
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Using a credit card for big purchases can be a good idea, but only if certain conditions are met. Not everyone has a 0% interest credit card, for one thing, and not everyone can be sure that they can pay off the balance in 12 or 18 months. The worst-case scenario is that they don’t really try to pay it off, and end up with interest rates so high that they can’t even handle those, let alone the actual balance.
But enough about that – let’s talk about personal loans, and how they could fix some of the problems presented by credit cards.
When to get a personal loan
Personal loans might sound a little scarier than using a credit card, but getting one could actually work out better in the long run. Getting a loan is a good way to put some accountability into your payment schedule; rather than the deceptively low monthly minimums on a credit card, you’ll have a strict payment plan with a fixed end date. This will ensure that you prioritize paying off the debt, and don’t end up paying extra interest fees that you didn’t initially plan for. Even if you tend to have good personal accountability, the stricter payment plan of a personal loan will help you stay on track.
It’s likely that when you’re applying for a loan, you’ll have to jump through plenty of hoops to prove that you can handle the payments. If your idea of the amount of debt you can take on is unrealistic, a lender will be able to analyze your credit history and financial information, and decide that while you’re likely to be able to pay back some of the loan, you might have a hard time paying back all of it. While this sounds like a let-down, it might save you from financial problems later on.
Personal loans can also improve your credit score, just like using your credit card can. If financial institutions can see that you were approved for a loan at X interest rate for Y amount (and that you paid it off on time), then your credit score will go up, and you’ll get even better rates on your next loan. AmOne loans to people with lower than average credit scores, but interest rates will start around 3.99%, although still less than most credit cards after a couple of months.
If you have a fairly good credit score and get a loan, you’ll probably be paying around 10% in interest each month – much better than a credit card’s interest rates. You’ll also have to pay 1% – 8% in lender’s fees, with the percentage decreasing the larger the loan amount is. Even with this additional fee, you’ll probably still be saving money by getting a loan. This is with good credit, though; if your credit score isn’t that great, the interest rates will go up.
What if you didn’t have to choose between one or the other, though? Are your card’s rewards just too good to pass up, but you still want the accountability and lower rates of a loan? If you don’t mind making things a little more complicated, you could put the expense on the credit card, then take care of the balance with a loan. With this approach, you can enjoy your card rewards and the lower interest rates of a loan at the same time.