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Are you starting a business? Buying a car? Doing home improvements? Have an upcoming expense that requires a large outlay of cash, which you just don’t have right now? You have a few options to get the money you need, and two of the most common are using a credit card or getting a loan from the bank. Which one is the better choice? That depends.
In most cases, it makes more sense to get a bank loan. A loan from the bank offers several benefits you won’t get from a credit card:
- Fixed monthly payments
- A lower interest rate than most credit cards
- Terms of three, five or seven years
- A fixed total you’ll pay back (including interest) by the end of the loan — but if you pay it back sooner, you’ll save money on the interest you don’t have to pay
- Tax deductions on the interest (in the case of a home equity loan)
- Can borrow larger amounts than with many credit cards
On the other hand, a credit card has benefits of its own:
- Easier to get than a bank loan in some circumstances
- Cash back or travel rewards
- Zero percent introductory interest rate on many credit cards
- Warranty protection on your purchases
- Monthly minimum payments decrease as you pay down your credit card
- A credit card is unsecured debt — you won’t lose your house or car if you can’t pay (but you will lose your good credit rating)
The danger with a credit card is that because you don’t have to pay it back within a fixed time period, you may let the debt sit for years as you make only the minimum payments. You could wind up paying thousands of dollars in interest for the money you borrowed. It’s also tempting, when times are tight, to pay your secured loans first and default on your credit cards. This can ruin your credit rating.
With this information about both types of debt, let’s explore the different situations in which you may want to borrow money.
Home Repairs/Home Improvement
You’ll get double the tax relief if you take out a home equity loan or home equity line of credit for home improvement projects that will make your house more energy efficient. Not only is the interest on your second mortgage tax deductible, but you’ll get tax credits for the improvements. Also, in many cases you’re improving the property value of your home.
The only reason you might want to use a credit card for home improvements is if you can’t refinance for some reason. Before you put home repairs (other than emergency repairs like a new heating system) on a credit card, ask yourself: Will you be able to pay off your credit card in a reasonable amount of time?
A car loan is a secured bank loan, in which your car can be taken as collateral should you default on the loan. The lower interest rates and fixed monthly payments over the life of the loan make a car loan your best bet for a vehicle purchase.
When you go to a bank for a business loan, you’ll need to show a business plan and reasonable expectations for profit. Or, you could wing it and charge all your new business expenses on your cash back credit card.
The legwork the bank requires puts you in a much better position as a new business owner. You’ll need a very clear picture of your expenses, potential profits, business challenges, competition, and opportunities. If you take the time to create a business plan and proposal, and have good personal credit, you can secure a better interest rate from your bank than you can with most credit cards.
There’s one benefit to charging business expenses — you’ll get warranty protection on purchases like office equipment and computers. In this case, borrow the cash from the bank, charge the purchases, and pay them off immediately. The American Express Platinum Card or the Amex Plum are great credit cards for new businesses.
Your car breaks down. Your beloved pet requires expensive emergency medical care. You discover you have to move — quickly — and need a security deposit for a new place and cash for a moving truck. These life tragedies happen and if you don’t have an emergency savings fund, you’ll be left with few choices.
Unsecured bank loans are very hard to get and, in situations like the ones above, you may have no choice but to put the expenses on your credit card. Use a card with zero percent interest for a year, if possible, and make steady monthly payments of whatever your budget will allow to pay it off as quickly as possible. If your minimum payment goes down, continue paying above the minimum to pay off your credit card faster.
Sometimes life circumstances force us to use credit cards but in most cases, we can get better interest rates with a bank loan.