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Small Loans vs. Credit Cards: What’s The Difference?
●May 13, 2021●4 minute read
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When you need short term financial assistance, the two main options many people consider are credit cards and small loans. Both of these allow you to borrow money, but how do they compare? What exactly is the difference between a small loan and a credit card?
What is a small loan?
A small loan is a personal loan in which you receive a lump sum payment to repay in instalments over an agreed period of time. You receive your money to pay for your expenses and you repay the lender in regular instalments. For example, if you borrow $2,000 with a 7% interest rate over two years, you will be required to pay $90 per month and end up paying a total of $2,149 (an extra $149 in interest).
What is a credit card?
A credit card is a card issued by a financial institution that allows you to spend up to your credit limit. A credit limit is a specified number that you are allowed to spend up to but not exceed. For example, if you have a credit card with a limit of $2,000 per month, you can spend any amount up to $2,000 in that month. The next month, the limit resets and you can spend up to that $2,000 once again.
With a credit card, you’ll be given a minimum repayment amount, usually a percentage of the money, each month that you must meet. If you repay your total money spent for that month, you will not be charged interest. Alternatively, if you pay the minimum amount, you can be charged the accompanying interest rate.
Small loan vs. credit card: what’s the difference?
The main difference between a small loan and credit card is they’re a different type of credit. With a small loan, you are given the total amount of money in hand and given set repayment terms. On the contrary, a credit card allows you to spend as much as you’d like, on whatever you’d like, with no set repayment terms. This means you can be in-debt on your credit card indefinitely if you never repay your balance.
A key difference between small loans and credit cards is the repayment structure. Small loans have a set life, meaning that you will repay your amount borrowed within the timeframe you agreed to. A credit card has more flexibility in that you can spend as much or as little as you’d like from month to month. There is no set date that your credit card will be paid off, as it is completely up to you. This can be seen as a benefit or drawback, depending on the user.
Generally, personal loans typically come with lower interest rates than credit cards. According to Reserve Bank data from September 2020, the average interest rate for credit cards is 19.94% p.a.. Alternatively, personal loans have an average interest rate of around 10% p.a. While small loans generally have a better interest rate than a credit card, there is one main difference: you don’t need to pay interest on a credit card. If you repay your total balance, you will not be charged interest.
Credit cards and small loans also come with different fees. Personal loans typically charge two main fees: an establishment fee and an annual or monthly fee. Credit cards can also include a much larger range of fees, including:
- Annual fees;
- Currency conversion fees;
- Balance transfer fees;
- Late payment fees;
- ATM fees;
- Dishonour fees;
- Over the limit fees;
- Replacement card fees.
It’s important to remember that this is a general idea of the fees you can expect to pay. Different types of fees are subject to the individual lender.
Key differences between small loans and credit cards
To sum up what we’ve discussed so far, here are the key differences between small loans and credit cards in the table below:
- An instalment loan
- Secured or unsecured options
- Known end date that your loan will be repaid and you will be out of debt
- Can have lower interest rates than credit cards
- Revolving credit
- Secured or unsecured cards
- Can have 0% interest if the total amount borrowed is repaid
- Can stay in debt indefinitely if you are always spending more than you pay off
- Typically has higher interest rates
So, which one do I choose?
There’s no one-size-fits-all answer as it depends on your individual circumstances and preferences. Generally speaking, credit cards are more suited to flexible, frequent spending. If you would rather have flexible and ongoing access to finance, a credit card may be your choice.
On the other hand, small loans are more suitable for one large purchase with a structured repayment plan. If you would like to know exactly how much you are borrowing, how much you will be paying and when you will be out of debt, a small loan may be better suited to you.
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Written by Rachel Horan
Rachel Horan is a Content Writer for Jacaranda Finance. Rachel has previously produced content for Brisbane City Council, Black & White Cabs, and Clubs Queensland. She has a Bachelor of Mass Communication with Distinction from the Queensland University of Technology.