Rachel Robson weighs up the pros and cons of taking out a low APR credit card versus a personal loan...
If you suddenly found yourself needing to borrow some extra money, would you be more inclined to simply whack it on a credit card, or would you prefer to take out a personal loan? Do you even have a preference?
Here, I’m going to investigate the pros and cons of both....
Credit cards
Let’s take a look at credit cards first.
If you are thinking of borrowing on a credit card, your first port of call might be a 0% new purchases credit card. These nifty bits of plastic allow you to spend on them without charging interest for up to a year and the market-leader is the Tesco Clubcard Mastercard which allows you to spend interest-free for 13 months. Alternatively, Sainsbury’s and Barclaycard allow you to spend interest-free for 12 months.
But the problem with 0% cards is you need to ensure you pay off your bill in full before the promotional period comes to an end - otherwise you'll get hit by a hefty interest rate.
If you can’t pay it off, you’ll have to transfer your debt to a 0% balance transfer credit card and pay a fee - and then another one (and pay another fee) if you still haven’t managed to pay off your bill in full by the time the interest-free deal has expired.
Continually switching from one credit card to another (known as rate tarting) can become a bit of a hassle - particularly if you need to borrow over the long-term. As a result, you might find you're better off using a low APR credit card such as the Barclaycard Platinum Simplicity Visa, which offers an interest rate of 6.8% on balance transfers and purchases, with no balance transfer fee. Alternatively, the MBNA Rate for Life offers an interest rate of 5.9% on balance transfers made now (16.9% on purchases), with a 2% balance transfer fee.
The great thing about these cards is that the rates of interest stay that low on your balance transfer for the duration.
And with the Barclaycard Platinum Simplicity Visa, you can spend on the card (not that I am encouraging you to do so) as well as pay off existing debt, and rest assured that you will be paying a very low rate of interest.
Flexible payments
Credit cards also allow you to be pretty flexible with your payments. Of course, you could simply pay off the minimum monthly repayment each month. But generally, the minimum payment is set at such a ridiculously low level (often as low as 2% of your total credit card debt), it will take you an incredibly long time to pay off, and you’ll end up forking out a lot in interest in the process.
Ideally, you should pay off more than the minimum monthly repayment – providing you can afford to do so. But even if you can’t initially, with a credit card, it’s easy to amend your monthly payment later down the line if you find you can afford to pay off a bit more.
And of course, this means if you suddenly win the lottery, or inherit lots of cash after your Great Aunt Marjorie dies, you can throw a lot more money at your credit card and pay it off completely. Bonus!
Money transfers
If you already have an expensive debt to pay off, such as an overdraft or a loan, some credit cards, such as the MBNA Rate for life, allow you to carry out money transfers.
This means you can move money from your credit card into your current account and then put this cash towards your overdraft or loan and still enjoy the same great interest rate (5.9% for the MBNA card).
Normally you have to pay 4% of the amount you are transferring as a fee, but right now, on the Rate for Life card, MBNA will allow you to do a money transfer for just a 2% fee. You have to do it within the first 60 days of getting the card.
This is a pretty unusual offer and is unlikely to last long.
Just make sure if you do this, you cut up the card immediately. Don’t spend on this card or you’ll be charged 16.9% on your purchases.
Extra benefits
Your credit card may offer additional benefits, such as a way to reward you for your spending. For example, the Barclaycard Platinum Simplicity Visa allows you to join the Barclaycard Freedom Reward scheme which means you can collect Reward Money at certain retailers and this can then be redeemed on your next transaction.
The cons
So now you know the pros of using a low APR credit card, let’s take a look at the drawbacks.
Fluctuating interest rates
One problem with a low APR credit card is that the interest rate isn’t fixed. Unfortunately, this means it could change when you least expect it.
That said, credit card companies offering low APR cards cannot increase interest rates within 12 months of a credit card being taken out. And after the first year, rates shouldn’t be increased more than every six months.
With the MBNA Rate for life, you’re guaranteed an interest rate of just 5.9% on the life of the transferred balances, so you won’t ever have to pay more than this on the balance you transferred.
The spending temptation
Once you’ve successfully got your hands on a credit card, it can be really easy to keep on spending. Unless you’re disciplined, it can be far too tempting to spend right up to your limit – even if that’s more than you intended to spend.
Borrowing limits
Finally, the credit limit you receive on your card may not be as high as you want it to be, which could prove problematic if you need to borrow a fairly large sum.
Ultimately, your limit will depend on your credit history – the better your credit record, the higher your limit is likely to be.
Loans
So that’s credit cards. Now let’s take a closer look at personal loans. Here are some of the benefits:
Get your hands on cash
One advantage of taking out a personal loan is that it means you can get your hands on cold hard cash. So if you need to pay for something in cash, rather than on a credit card, this might be the preferable option.
Fixed interest rate
The interest rate you will receive on your loan will be fixed. So if you’d prefer to have the reassurance your interest rate won’t change during the term of the loan, this might sound more appealing.
For example, both Alliance & Leicester and it parent Santander offer a typical APR of 7.3% on their loans. This is the market-leading rate and is on offer for loans between £7,500 and £14,950.
There’s no doubt it’s a competitive rate – in fact it is the lowest rate that, here at lovemoney.com, we’ve seen for years. But that doesn’t necessarily means it’s the best option for you.
Fixed term
Like the interest rate, the term of the loan is fixed. So you will know exactly how long it will take you to pay off your loan in full. This is unlike a credit card where the term will depend on how much you put towards your credit card debt each month.
Borrow more
With a loan, you’re also likely to be able to borrow more than with a credit card. So if you know you will need to borrow a fair bit, a loan may be more suitable. That said, you’re still going to need a decent credit history to get the best deals.
The cons
Those are the pros - wanhat are the cons?
Higher interest rate
One drawback to personal loans is that you’re likely to end up with a higher rate of interest with a personal loan than with a credit card. Clearly, the balance transfer cards I mentioned earlier are much cheaper than even the most competitive loans on offer.
Less flexibility
The other problem with personal loans is that they’re not as flexible. This means you can’t keep changing how much you pay towards your loan each month. What’s more, it’s harder to pay off your loan in full if you suddenly find you have lots of spare cash on your hands.
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Although early repayment is usually possible, you will find that you’re likely to get penalised for doing so. For example, you may be charged a fee of one month’s interest.
So this is something you should bear in mind should you decide to pay it off early.
Decisions, decisions
Overall, my personal preference is to opt for a credit card rather than a personal loan. And that’s simply because I like the flexibility a credit card offers. Knowing I can change my payments should I need to is a bonus in my book, and of course, credit cards offer better interest rates.
Our top pick if you want one easy credit card for long-term spending and paying off existing credit card debt is the Barclaycard Platinum Simplicity Visa, which charges 6.8% APR. Alternatively, if you want pay off debt gradually but need some cash to spend immediately, go for the MBNA Rate for life and do a money transfer within 60 days. You’ll pay 5.9% APR for the life of the transfer, plus a 2% handling fee.
That said, if you’re looking to borrow a fairly large sum of money, or you’re not terribly disciplined and are likely to get carried away with a credit card, a personal loan is probably the better option. After all, it ensures you pay a fixed amount over a fixed term, and can therefore offer a stable way of borrowing. Plus, it removes the temptation to keep on borrowing.
Here, our top picks are Alliance & Leicester and it parent Santander which both charge 7.3% typical APR.
So whichever option you go for, make sure it’s the right one for you, and shop around to ensure you’re getting the best deal. And, as always, read the terms and conditions carefully!
More: 10 traps to avoid when taking out a loan | The cards you’re conned into using
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This is a classic article which has been updated.