Some of those options can have much higher interest rates than others, especially if you can’t pay the money back in full right away. That’s why it’s important to do your research before you borrow money.
Two of the most popular ways you can access funds, if you don’t have a bank account overdraft, are through personal loans and credit card cash advances. Both of these types of loans have their positives and negatives. They also affect your credit score in different ways.
Personal Loans and Credit Card Cash Advances: How They Affect Your Credit Score
Believe it or not, not all credit accounts affect your credit score in the same way. This is because there are actually several types of credit, and each affects your credit score differently. Personal loans are a form of installment credit,t while credit card accounts are a form of revolving credit.
Personal Loans
How installment credit works, specifically with personal loans, is that it’s based on your payment history. The amount of the loan makes no difference, credit-wise. As long as you make your monthly payments on time, you have a positive impact on your credit score. Even after the loan is paid off, it will still show as positive history on your credit report. It will also be reflected in your credit score.
Credit Cards
When it comes to credit cards or any form of revolving credit line, your payment history, as well as your balance, will reflect your credit score. This is because revolving credit is a form of credit you can spend and pay off as much as you’d like. The general rule with credit cards is also that you want to keep your balance at least 35% or less of your total credit limit. Keep in mind that this is your total limit, not just the one form of revolving credit. The higher your credit card balance, the lower your credit score will be.
Personal Loans and Credit Cards: How the Interest Rates Differ
With both credit cards and personal loans, the interest rates differ depending on the one you choose. Your credit score can make a big difference in which credit card or personal loan you get approved for, as well.
Personal Loans
The interest rate on personal loans varies with the Bank of Canada’s prime rate. That said, they can generally range anywhere from 5% to 34.99%. It just depends on the loan that you are approved for and the lender that you choose.
With most personal loans as well, they are considered to be open loans in the sense that you can pay them off in full whenever you choose. Personal loan interest rates can be simple or compound. Credit card interest rates are compound interest.
Simple Interest Personal Loans
Simple interest loans mean you pay interest only on the outstanding principal (the amount you took out, not including interest). The higher your principal amount owing is, the more interest you pay. With your first loan payment, the majority will go towards interest.
As the principal amount decreases, less money goes toward interest payments, and more goes toward the principal. By the time you are near the end of the loan period, the majority of your payment is being put towards the principal. This continues until the loan is paid in full.
Compound Interest Personal Loans
Compound interest loans work a bit differently. The amount you pay is based not only on the loan principal you owe but also on the interest accrued. This only happens if you miss a payment or make a late payment.
Any unpaid interest accrued will be added to the balance of what you owe. For this reason, compound interest is sometimes referred to as interest on interest. Depending on the type of financing you get, the compounding periods will vary. With a compound interest personal loan, the accrued interest is compounded on a specified term, usually monthly.
Credit Card Interest
The interest on a credit card varies depending on the type of credit card that you get. That said, the most common interest rate among credit card issuers is 19.99%.
When you purchase with your credit card, there is a grace period, and you usually don’t have to start paying interest until the credit card bill date—typically 30 days or so after the purchase. If you pay it off before then, then you don’t pay interest on your purchases. If you don’t pay it within that period, you will have to pay interest.
Credit card interest is different from personal loan interest. Credit card interest is compound interest that compounds daily, once the grace period has ended. Your credit card provider will add interest charges each day based on your balance from the day before. These are then added up every month to determine your monthly interest amount.
This is why credit card debt can be much more difficult to pay off than a personal loan. While it is more convenient, since you don’t have a set amount to pay toward the principal every month, that flexibility can end up costing you substantially more in the long run.
The Cost of a Credit Card Cash Advance
Most credit cards also charge a higher interest rate on cash advances. This cash advance APR is usually 2% to 3% higher than the average interest rate. This is known as the cash advance fee, and it applies to each cash advance transaction. For most credit cards in Canada, including balance transfer cards, this rate is around 21%.
Cash Advances and Grace Periods
When it comes to cash advances, there is no grace period. This means you’ll have to start paying interest the moment you gain access to emergency cash. The grace period is typically 21 days and applies only to traditional credit card purchases. A cash advance fee is separate from the interest charge.
The ATM Limit for Cash Advances
In Canada, your ATM withdrawal limit is generally between 10% and 40% of your credit card limit, since a credit card is considered to be revolving credit. With an ATM, the limit is generally between $500 and $1,000. To find out your specific limit, it’s best to consult your credit card agreement.
Personal Loans and Credit Cards: Which is Better for Debt Consolidation?
Debt can slowly creep up on you until it is difficult to make all of the payments. Before that happens, it could be a good idea to get a consolidation loan. These loans are a great way to consolidate all your payments into a single monthly payment.
When it comes to choosing the best type of loan to consolidate your debt, an unsecured personal loan is the best option. This is because they have predetermined payments for a set period, usually at a simple interest rate.
Using a credit card cash advance not only means you pay a higher interest rate, but also that you incur daily compound interest on that amount. This could make your debt even more difficult to pay off, especially if it will take you an extended period of time to pay off the balance. To avoid interest piling up, you would have to make frequent, large payments.
It’s also important to note how a credit card cash advance works. There is a limit, usually 30% or your limit, on what can be taken out. Often, your debt exceeds the amount your credit card provider allows you to take out.
Using a Personal Loan to Pay Off a Credit Card
Instead of dipping into your overdraft to pay off your credit card bill, consider a fixed-interest loan. It gets you out of the minimum payment trap and reduces your utilization ratio as long as you don’t continue using the card.
In fact, when it comes to debt consolidation, installment credit not only reduces your interest accrual but also helps with credit repair and your debt-to-income ratio in your credit bureau reporting. It has a similar impact on credit score to a credit limit increase.
One of the main reasons that someone would choose to do a debt consolidation is the unsecured loan rates. They’re significantly lower than traditional credit cards because they’re based on the prime lending rate. They also have a fixed rate, unlike a line of credit, and they get you out of the credit card debt cycle.
APR Difference Between Loan Types
When it comes to loan versus credit card APR comparisons, you’ll see that there is a big difference. With a fixed-rate personal loan, the rate is between 10% and 15%, while credit card rates can range from 13% to 30%. However, credit cards accrue compound interest, whereas fixed-rate loans accrue simple interest.
The Best Way to Quickly Consolidate Debt
The best way to consolidate and eliminate your debt quickly in Canada is with a Home Equity Line of Credit. Due to the secure loan collateral, you’re likely to get a lower interest rate and access to more money. This avoids you having to take out merchant cash advances, online cash advances, or even incurring overdraft protection fees.
Before you decide to go this route, a loan payoff calculator can determine how long it will take to pay off the debt and what your payments will likely be. You’re likely to save a lot of money because you no longer have a minimum payment on your credit card and a defined installment payment plan.
With a HELOC, you’re going to find that your credit utilization ratio might change, as well as your credit mix on your credit report. Your daily interest charges are going to be much lower, and you may even be able to start a financial emergency fund.
How Missing a Loan Payment Impacts Your Credit Score
When it comes to your credit profile, many factors are going to make an impact. These include:
- Credit card limits
- Overall credit limits
- How much revolving debt do you have
- Credit mix
- Missed payments
When you miss payments, you’re going to notice your credit score decrease very quickly. Since personal loans offer lower interest rates, consolidating your debt can make it easier to keep your payments on time.
To avoid any more missed payments and keep your credit score intact, a loan consolidation calculator can help you decide between both personal loans and balance transfer cards or if one of each is a better option. Either way, you’re going to notice that keeping up on your payments and the fixed interest rates, it won’t be long before you have strong credit again.
Personal Loans and Credit Cards: Which is Easier to Get?
To get personal loans and credit cards, you do need to have a decent credit score. That said, credit cards are generally easier to get than personal loans. They do, however, have a lower limit than personal loans.
When it comes to getting a credit card, your credit score and total income amount make a difference in how much you are approved for. Just because you get approved doesn’t mean you get a high limit. Surprisingly, in itself, a low-limit credit card is actually not good for your credit score. Say your limit is $500.
You need to keep your limits under 35% of the credit limit. That means your balance needs to be under $175. Not being able to meet this limit can hurt your credit score, making it more difficult to get approved for financing in the future.
Personal loans are slightly harder to get than credit cards, but not by much. The thing about personal loans is that it’s more difficult to get approved for a good interest rate than it is to get approved. You do need to have some form of credit history, though, for most lenders to approve you.
How Credit Impacts the Type of Personal Loan You Can Get
There are plenty of options when you are applying for a personal loan. The most popular is an unsecured loan. You don’t need a great credit score to qualify for an unsecured loan, but it will help you get the best interest rate. If you have a lower credit score, it may be more difficult to get approved.
In some cases, with a poor credit score, you may not be able to have an unsecured loan. This could result in having to get a secured loan or a cosigner. A secured loan is risky because if you are unable to make your payments, you may lose the item you put up for collateral.
A cosigner loan is challenging because finding a cosigner is difficult. The per is signing for you, essentially taking responsibility for the loan if you are unable to make the payments. They must also have a good credit score and be approved.
CTA: If you are looking for a personal loan, Spring Financial can help. We offer personal loans ranging from $500 – $35,000, with rates starting at just 9.99%. Apply online today.
Disadvantages of a Personal Loan Compared to a Credit Card
While personal loans can be better for your credit score, there are some disadvantages to personal loans as well. In some ways, credit cards offset these disadvantages.
- Fixed monthly payments are a great way to maintain, but sometimes they can get a bit expensive. Credit cards only have a set minimum monthly payment; the principal can be paid at any time.
- Fixed loan amount: With personal loans, once you receive the loan, that is the maximum amount of money that you can get. As you pay it off, you can’t continue to use the loan amount either. Credit cards, on the other hand, are revolving. This means that once you pay off your card, you can use it again. You can actually continue to use it as long as it isn’t maxed out.
- Interest rates: If you have poor credit, the interest rate on a loan can be quite high. With credit cards, the interest rates are the same for everyone. If you pay off the outstanding balance before your bill is issued, you can avoid paying any interest.
- Extra fees and penalties: Some personal loans give you penalties for paying off your loan early or making extra payments. There are also administrative fees that are added to your loan amount. Sometimes, even insurance amounts. This is not the case with most credit cards.
Difference Between Advances and a Personal Loan
There are a few major differences between cash advances and personal loans. Personal one-time loan that remains until you pay the balance. They have a set monthly payment and interest rate. Cash advances work the same as a traditional credit card purchase, except that you withdraw money from the ATM. In some cases, you can also do a merchant cash advance. The only difference is that it has a higher interest rate. Here are the most significant differences.
- Payment Schedule: Personal loans have a fixed payment schedule. Credit card payments can be made at any time. The monthly payment listed on your credit card statement is just enough to cover the minimum payment (the interest). Making the minimum payments can make paying off the card take a long time.
- Interest Rates: Interest rates on care are usually around 19.99%. Interest rates on personal loans range from 5% to 34.99%. You need to keep in mind, though, that personal loans are more often than not simple interest; those that are compounded do so only on accrued interest, unlike credit cards, which are compounded daily. Even though 19.99% doesn’t sound as bad as 34.99%, it’s actually a very high interest rate.
- Effect on Credit Score: With credit cards, your credit score is affected not only by making your payments on time, but also by. Personal loans affect your credit score by payment history only.
- Cash Amounts: With a personal loan, you can take out the whole amount of your loan in cash. Credit cards have a cash advance limit. It’s usually 30% of your total credit limit on your card. Your credit card company may have a different limit, though.
Loans or Credit Card Debt: Which is Better When Getting a Mortgage?
When it comes to getting a mortgage, you want to pay off your highest interest rate debt first. That is usually your credit cards, unless you have payday loans. The reason for this debt-to-income ratio makes a big difference in how much you can borrow for a mortgage. You want the debt-to-income ratio as low as possible.
Final Thoughts
When deciding between a personal loan, a credit card, or a cash advance, there are many things you need to consider, including:
- Cash withdrawal fees
- Repayment terms
- Origination fees
- Which has the lower interest rate
- The approval process
- Additional fees
Since personal loans tend to have a lower rate, these traditional loans can help you avoid paying interest continuously and even increase your cash flow. Since it also reduces your carrying balance, you have more money for everyday purchases. It can even allow you to save money in an emergency fund to cover unexpected expenses.
Having the funds to cover your bills and short-term expenses during a financial emergency makes more sense in the long run and can dramatically improve your financial situation.
