Loan Basics. Face-off — credit cards and personal loans

Despite strong financial planning, unforeseen circumstances like a medical emergency in the family or an unplanned trip can land us in a financial crisis. When you fall short of funds, using your credit card or taking a personal loan are two of the most common options. Here’s a comparison between the two across various parameters, which should help you choose according to your needs and repayment capability.

When using your credit card, either directly or through a loan against it, you can usually borrow only up to your pre-determined credit limit. Credit-card issuers set this limit based on your monthly income and past payment track record.

Some credit-card issuers, though, offer you a loan over and above your credit limit where the loan amount will not be blocked against the credit limit.

The concept of credit limit also indirectly applies to personal loans in the form of maximum loan eligibility. Lenders will approve your personal loan amount on the basis of various eligibility criteria such as your credit score, monthly income, employer and existing EMI commitments.

Generally, lenders prefer your total EMI commitments, including that of your fresh personal loan, to stay within 40-60 per cent of your monthly income. Net-net, a personal loan can provide you a higher loan amount.

Interest rates on personal loans range between 10.99 per cent and 24 per cent a year, depending on your credit score, monthly income, employer, loan amount and repayment tenure. On the contrary, credit cards finance your spends for free for up to 30-45 days till your bill is due. However, failing to clear your dues will attract finance charges in excess of 36-47 per cent. The smarter choice will be to convert your dues into EMIs in such cases as it will cost you a lower interest rate of 15-25 per cent a year. So, on the interest front, personal loan is cheaper.

Disbursal of conventional personal loans may take two to seven days. Access to credit through a credit card, however, can be instant. Even a loan against credit card is usually processed the same day since it does not involve any additional documentation. Getting a personal loan will involve processing charges of 0-2.5 per cent of the loan amount, depending on the lender, loan amount and borrower’s profile.

Swiping your credit card does not involve processing charges, but if you convert your outstanding into EMIs or take a loan against your card, you may have to pay processing charges of up to 3 per cent

Personal loans usually have repayment tenure of 12-60 months. Repayment of your credit card dues, however, does not come with any pre-determined schedule. Opting for part-payment or a delay in payment of your outstanding balance can prove to be costly. However, credit card EMI option and loan against credit cards have repayment periods of 3-24 months and 6-60 months, respectively. Opt for credit card options if you are planning to repay the loan amount in less than a year, otherwise go for a personal loan.

Prepaying your personal loan can cost you a prepayment fee amounting to 2-5 per cent of your outstanding balance. Moreover, prepayment is allowed only after the repayment of a certain number of EMIs. However, some lenders do not charge any penalty on prepayment of personal loans. Credit card issuers also impose similar restrictions on prepaying outstanding balances of loan against credit card and card balances converted into EMIs. Prepayment penalties can go up to 3 per cent of the outstanding balances while prepayment is not allowed until the completion of six months.

Use your credit card for meeting financial exigencies or last-minute expenses if the required amount is small and your need for funds is immediate. Convert your dues into EMIs if you cannot repay the total outstanding amount by the next due date and you are sure of repaying it within three-six months. Opt for a loan against credit card if it costs less than the credit card EMI option.

If you are seeking a higher loan amount and can wait for a few days for the disbursal, go for a personal loan as it may cost you lesser. Moreover, doing so will keep your credit limit on your card free for financing daily spends and future exigencies.

Finally, check with your banker and credit card issuer(s) to know about the credit offers they have for you, based on your existing banking relationships. Also, scout for the best personal loan options available before you zero in on one.

The writer is CEO & Co-founder, Paisabazaar.com