When you are struggling with debt, the difference between various types of loans, credit cards and other debts can seem small. But, in reality, there are a few big differences between some types of loans and credit cards. Although each involves borrowing money, there are big differences when it comes to the amount of interest you end up paying and how the loan affects your credit.
Type of Loan
One difference between personal loans, credit cards and other loans is the type of debt they are. Credit cards are a type of revolving debt. When you open a credit card, you usually have a set credit limit, such as $5,000. You can borrow up to the full $5,000 on the card, repay it, then borrow another $5,000, repay it, and so on. You can also choose to borrow much less than your limit, such as $100.
Other loans, such as your mortgage, a car loan and personal loans, are often installment debt, meaning you borrow the full amount at the start of the loan, then repay it in predetermined monthly amounts. If you’d like to speed up the rate at which you repay an installment loan, you have the option of making additional payments each month, although some lenders do charge a penalty for doing that.
The interest rate charged is often different on credit cards than it is on other loans. For example, mortgage interest rates tend to be in the single digits, while a credit card interest rate can be above 20 percent. It’s worth noting that a higher interest rate doesn’t necessarily mean a loan is more expensive. While your credit card might have an annual percentage rate of 18.99 percent and your mortgage has a rate of just 4.5 percent, your mortgage can be the more expensive loan. If you use your credit card and are able to repay the balance in full before the end of the grace period, you won’t be charged interest. There’s usually no grace period on installment loans.
Some types of loans, such as a car loan or mortgage, have collateral. If you don’t pay your mortgage, a bank might foreclose on your home. If you don’t make payments on a car loan, the lender can repossess your car. Personal loans and credit cards usually don’t have collateral, which is part of the reason why their interest rates tend to be higher.
Impact on Credit
Any type of loan or a credit card can have a negative effect on your credit score if you end up deep in debt or struggle to make payments on your debts. But, the way the loans impact your credit is also slightly different. For example, if you borrow a lot of money on a credit card or other form of revolving debt, you affect your credit utilization ratio, meaning it looks as though you’re using a lot of the credit available to you, which can be a red flag to lenders. If you were to borrow the same amount with a personal loan or another installment loan, your credit utilization ratio wouldn’t be affected, although applying for the loan would affect your credit. If you paid the installment loan as agreed, the impact on your credit would be minimal.
If you feel overwhelmed by your debts or need assistance when it comes to working with your creditors, we can help. CESI offers non-profit credit counseling and debt management plans that help you get your financial life back on track. To learn more about how we can help, contact us today.
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Consumer Education Services, Inc. (CESI) is a non-profit service provider of comprehensive personal financial education and solutions for all life stages and for all of life’s milestones. Our goal is enhanced economic security for everyone we serve.
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