Generally speaking, most people have three levels of purchases they make at any given time. At the low end of the financial impact spectrum, there’s the day to day spending on things like coffee, groceries, and meals at restaurants. Depending on budget, this may include ample spending on clothes as well. At the top, there’s the massive, often life-altering purchasing of assets, which includes buying a home or a car. And in between these two levels, there’s the large purchases.
Large purchases include things like buying a new computer, upgrading a mattress, and getting new furniture. Whether it’s an emergency replacement or something you’re opting to splurge on, these purchases tend to cost significant amounts—something you might not have on hand. That’s where a credit card or personal loan comes in handy. But which is better to use?
The pros of using a credit card for large purchases
It’s rare to find a credit card these days that doesn’t come with at least one perk. Some of the pros of using credit cards include:
If you already have the credit card on hand, there’s no need to go through an application process and wait for approval (not to mention that the application will ping your credit score). The credit card is available to use right now.
0% Intro APR
You’ve probably gotten offers in the mail advertising 0% introductory interest periods for a certain number of months after you open a new credit card. If you make a charge to this card and pay off the full balance before the 0% intro interest period ends, then you basically got an interest-free loan.
In addition, says James Lambridis, CEO of DebtMD, “When making a substantial purchase from a retail store, whether it be a home appliance or piece of furniture, many stores offer the option of opening up a retail credit card to finance that purchase. Most of the time they will offer you 12 months at 0% intro APR (Annual Percentage Rate) or more, so as long as you can pay it off before the interest kicks in, it’s a no-brainer.”
Pro tip: You can also do a balance transfer of other credit card debt to a card with 0% intro APR in order to minimize interest charges.
Points and miles
These days, the majority of credit cards offer some sort of points or miles accumulation system that can be redeemed for things like online merchandise, other retail discounts, and travel rewards. When you finance a large purchase on one of these cards, you could quite literally be contributing to an upcoming vacation.
In addition to 0% intro APRs, many credit cards offer massive points and miles bonuses for signing up for the card and spending a specified amount within the first few months of opening the card.
“When making large purchases, I always go with credit cards,” says Alex Tran, a digital marketing strategist at Hollingsworth. “I signed up for an American Express Platinum card and earned the equivalent of two round trips.” Once you’ve used the card to earn your welcome bonus, it’s up to you how proceed with it. “Always try to negotiate with credit card companies when you need to downgrade a card. Never cancel it because it can affect your credit score,” Tran advises.
Cash back bonuses
Similar to points and miles accumulation, many credit cards offer a percentage of cash back on every dollar you finance. If you opt to use this type of credit card for a large purchase, you are essentially buying it with a built-in sale.
The cons of using a credit card
Using a credit card to finance a large purchase comes with a lot of short-term perks, but there are drawbacks as well.
High interest rates
Credit cards generally have a much higher interest rate than personal loans. Currently, the average is around 17%.
Late payment penalties
Being late on a credit card payment can come with a number of consequences — none of them particularly fun. In the same way you can be charged a fee for overdrawing on your checking account, a penalty fee can be added to your balance if you don’t make your minimum credit card payment on time. Some credit card issuers, such as American Express, will also increase your APR for a period of time as a penalty for being late on your payment. And of course, late payments will appear on your credit report, which most likely lowers your FICO score.
Ease of spending
The traits that make credit cards so convenient are also what makes them so dangerous. If you let your credit card debt get out of hand it can send your credit score into a downward spiral, especially if you go over your credit limit.
The pros of a personal loan for large purchases
Using a personal loan to finance a large purchase has a lot of advantages, including:
Low interest rates
The interest rate for a personal loan depends on your credit score, but in general, they have a lower interest rate than a credit card APR. Personal loans work best for borrowers with good credit or excellent credit.
“With larger purchases, since you most likely will not be able to pay off the balance in the one year that a credit card will offer you promotional 0% interest, you are better off locking yourself in at a reasonable interest rate with a personal loan,” advises Lambridis.
Tip: If you originally finance your purchase with a 0% intro APR credit card, and then find you need more time to pay, you can take out a debt consolidation loan to make payments at a lower rate than on the credit card.
Fixed monthly payment
Unlike with a credit card, where minimum payments fluctuate based on the balance, personal loans have a fixed monthly payment for a fixed term, so it’s easier to plan your pay off strategy.
Cash on hand
When you take out a personal loan, it puts a lump sum of cash in your hand, which in some ways, has more power than a credit card. “Depending on the type of purchase, you may be able to get a discount when paying with cash,” says Lambridis. “Many home contractors and wedding venues will cut you a break in the price if you pay with cash as opposed to credit. The bigger the purchase, the more these savings could add up.”
The cons of using a personal loan
Even with the low interest rates and flexibility of having actual cash, a personal loan still has drawbacks:
Whereas a credit card is something you carry with you, a personal loan has to be applied for, and lenders then have to approve the application before they finally deposit money in your account or send a check. This process can take days or weeks, requiring a lot of planning to make your purchase.
Since a personal loan generally has a low monthly interest rate, lenders want to maximize their profits by ensuring borrowers pay the loan for as long as possible. For this reason, some loans have steep penalties if you pay it off early.
Some loans also come with a fee for processing the loan application, ranging between 1% and 6% of the total loan amount.
The bottom line
Before you choose to finance your large purchase with a credit card or personal loan, carefully assess your credit history and income beforehand and determine how long it will take to pay for the item you need now, and how much it will cost you over the life of the re-payment.
Have you made any large purchases lately? Do you prefer to use a credit card or personal loan?