If you find yourself in a situation where you need a little financial help, take time to think about your options. Automatically reaching for a credit card might not be the best money move.
You want your choice to minimize the risk of making your debt worse than it already is. According to the Federal Reserve, consumer debt increased $20.1 billion month over month in August. Nonrevolving debt, which includes personal loans, increased at a higher rate than revolving debt, which includes credit cards.
Debt is on the rise, for sure, but you don’t have to become part of that trend. So, let’s take a look at how to decide if you need a credit card or a personal loan. Make the right choice, and before you know it, you’ll be on your way to fiscal sanity again.
When to Use a Credit Card
A few years ago, I had a giant hole in my kitchen ceiling. It was the unfortunate result of a leaking roof and a monsoon-like storm that lasted for five days.
The bill for this fiasco? A cool $16,000. I was fortunate to have an emergency fund and a credit card with a ridiculously low annual percentage rate (the perks of having a long, drama-free credit history). It was going to take my insurer some time to approve the coverage, and I needed to fix the roof before it rained again.
So, I used an insurance-approved contractor, and I put the expense on my low-APR credit card for the rewards. I like having a low-APR card just in case something goes wrong and I need to float the bill for a month or two.
When the credit card bill was due, I paid it in full from my emergency fund. Insurance paid for part of the repairs, so when I got that check, I reimbursed my emergency fund.
[Read: The Best Bad Credit Loans of 2018.]
Using a credit card worked because I earned rewards, I had the money in an emergency fund to cover the bill, and it was going to be a short-term financial problem.
But let’s change the scenario a bit. Let’s say you have your own version of my kitchen ceiling, but you don’t have an emergency fund and you need a year to pay off the bill. If you have good credit, then you could get a credit card with a zero percent introductory APR on purchases to fund your expense.
You’ll need to make monthly payments on the bill and pay it off before the intro rate ends. Right now, zero percent intro rates usually last from 12 to about 20 months. Note that the intro period for purchases may be shorter than the intro period for balance transfers. In that case, you may want to use a card you already have and transfer the amount to your new card. But be wary of transfer fees.
When is a credit card a bad idea? If it’s a long-term scenario, you’ll most likely get a better interest rate with a personal loan. Interest rates on credit cards likely will continue to rise, so they are not the right choice for a long-term loan.
When to Get a Personal Loan
Suppose you need to replace your heating and air conditioning unit, which also happened to me a few years ago. Yes, my house is in advanced middle age and it’s falling apart.
Your credit cards have APRs north of 20 percent, and your rainy-day fund is a little worse for wear. You’re looking at a $4,000 investment, and putting this amount on a high-interest credit card and taking a few years to pay it off would be kind of insane.
In this situation, getting a personal loan makes more sense. You’ll most likely get a better interest rate (unless your credit is bad), and you’ll be making fixed installment payments over a few years. You’ll have a set monthly payment to include in your budget.
Hop online and do some research so you get the best rate. You want to check out rate comparison websites, your own bank and outside-the-box options, such as peer-to-peer lending companies.
What if You Need to Consolidate Debt?
The answer to this is pretty simple. If you have great credit and you think you can pay off the debt in 18 months or so, then a balance transfer credit card is a good fit.
The only question is whether or not your credit limit will be high enough to cover all the debt you want to transfer. If it is, then you can pay off your debt at zero percent interest during the intro period. You’ll save a lot of money this way.
But what if you don’t have good credit or you need three to five years to pay off your debt? Then, it’s time to look at a debt consolidation loan.
Seeking the right debt consolidation loan takes time, but keep at it until you can find the best possible rate for your situation. You won’t get a zero percent interest rate, but for long-term borrowing, you’ll pay less interest with a personal loan than you will with a credit card.
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When Should I Get a Credit Card Instead of a Loan? originally appeared on usnews.com