A personal loan is typically used for purchases, emergencies, or debt consolidation. Personal loans from banks and credit unions are based on your income and credit score.
However, if you own a credit card, you may have another loan option sitting in your wallet.
A credit card loan can provide fast relief with the money you need, but is it worth it? in this article, we’ll take a look at what it means to take on a credit card loan
What is a Credit Card Loan?
A credit card loan is an amount of money that you borrow against your credit card limit. Just like you would use your credit to purchase, some cards will offer a personal loan option. You can repay a credit card loan amount in a fixed monthly payment structure like any other personal loan.
How a Credit Card Loan Works
Credit card loans are offered through your credit card company—you may most likely see them advertise through your card provider’s app or website. Although you will need to select your desired loan amount and review your options, you don’t need an application or credit check to receive your loan. After all, you aren’t applying for a new line of credit. And as a cardholder, you have already been approved as a borrower.
The minimum credit card loan available is about $500. Your creditor may approve a higher loan amount based on your creditworthiness, spending habits, and available credit. After you agree to the loan terms (interest rates, fees, and monthly payment schedule), your money becomes available to you. The entire application process typically takes a couple of business days.
Credit card loans have terms that give lenders anywhere from six months to five years to repay. The monthly payment for the loan is added to your minimum monthly payment due on your credit card.
Credit Card Consolidation Loan
Debt consolidation is a debt management plan that combines many debts into one affordable monthly payment. With a credit card consolidation loan, you use a different form of financing to pay off other debts and liabilities promptly. This way, individuals or families consolidate debt with a strategy beyond making regular monthly payments across several different accounts.
Loans and Your Credit Score
Your credit score will play a part in nearly every loan application process. If you’re thinking of taking out a personal loan, it’s essential to know that it could affect your credit score in the long term.
What is a Credit Score?
A credit score is the product of a mathematical algorithm that compares your credit information to the data of millions of other consumers. Your credit score provides a general indication of your creditworthiness, created from a review of your relationship with your past and current creditors—which is why every potential lender uses your credit score to help decide on your loan application.
Where Do Credit Scores Come From?
A credit score is a number that is calculated based on the information in your credit report. Between 300 and 850, this number can affect what kind of rates you may be offered in the future. The higher the score, the better the terms are for obtaining loans, renting an apartment, and other services. But not all credit scores work the same. That’s because there are a variety of scoring models from the three major credit bureaus, so it can be challenging to predict how it will affect your score.
But what exactly goes into your credit score?
The three main factors that go into your credit score are based on how long you have managed credit, the amount of debt you currently have, and how you have handled repayments in the past.
Credit Utilization Ratio
Credit utilization is a measurement of how much of your available credit you are using at any given time. For example, let’s say you have a credit card that has a limit of $1,000. At the end of a month of spending, the balance on the card is $200. That would make your utilization ratio 20% (20:100).
You should try to keep your credit utilization below 30%. For example, if your credit card has an $8,000 credit limit, you should try to keep a balance of no more than $2,400 on that card.
Although your credit utilization can heavily affect most personal loan decisions at a bank, a personal loan on your credit card does count the same way as a typical purchase. Personal loans are installment loans with a fixed monthly payment. On the other hand, regular credit card activity can fluctuate month-to-month, so it better indicates your actual spending habits.
However, using your credit card to pay off another personal loan will lower your utilization.
Credit History/Age of Credit
A credit report lists all of your past and current credit accounts to give lenders insight into how you’ve handled them in the past. A long history of credit accounts will provide great information to creditors about your relationship with your debt over time. Credit history will also help lenders make predictions on your future habits, which will affect the personal loan amount, interest rates, and services available to you.
In addition to not having a credit card at all, your credit history can be affected by either refinancing other personal loans or canceling a credit card after it is paid off.
Payment History
Your payment history is the record of all the on-time and late monthly payments a person has made to their creditors. Payment history is the most crucial part of your credit score; it gives potential lenders clear information about your ability to repay the money that you owe. For example, when you don’t make a monthly payment for more than six months, your account is sent to a collection agency—a move that can deduct as many as 100 points from a credit score. This is why we always remind you to pay your bills on time!
Credit Card Loan Advantages
A credit card loan is a personal loan that can be disbursed quickly. Since there is no credit check or extensive application needed, it’s possible to get your approved loan amount more quickly than a traditional loan. You can apply for a credit card loan at any time; the process is as easy as logging onto your online account or speaking with a customer service representative at your credit card company.
Since each monthly payment is added to your credit card payments, you don’t have to worry about sending off payment or adding a new item to your budget.
Credit Card Loan Disadvantages
Taking out a personal loan is detrimental to your credit health—even if it’s a credit card consolidation loan to eliminate debt. Depending on your credit card provider, these loans can also have different interest rates that may differ from your annual percentage rate (APR)
Credit Card Loan Alternatives
Traditional Personal Loan
Instead of getting a credit card loan, be sure that you have considered the options with your bank. Getting a secured loan (with your bank account as collateral) can be a solid option—especially when your bank can deduct an affordable monthly payment from your bank account.
Difference Between Personal Loans and Credit Card Loans
A personal loan is a better choice for significant expenses that will take a long time to pay off. Since credit card debt carries higher interest rates than personal loans, it’s better to use a lower interest rate on more significant purchases.
As we discussed, getting approved for a personal loan depends a lot on your past and current financial behavior. But, the personal loan you choose depends on your goals.
Merchant Cash Advance
If you are a business owner that needs a loan you can repay quickly, a cash advance for your business might work for you. Merchant cash advances are available from the service providers that process your customers’ credit card transactions. Instead of a monthly payment, you can repay this kind of loan with a portion of each transaction you conduct. Merchant cash advances can be tricky; their high-interest rates can eat into your profits if you don’t pay them back quickly.
Peer-to-Peer Loan
Conventional personal loans from financial institutions like banks and credit unions are often restricted to potential borrowers with good credit. With Peer-to-Peer (P2P) lending, borrowers connect with investors or investment groups looking to provide financing for quick loans to people who need money.
A relatively new personal loan option, P2P lending, gives people with bad credit a better chance at getting a lower interest rate on an installment loan. Traditional lenders may rely more on your credit score to determine approval and a loan amount, but P2P investors consider factors like credit history and income to determine which lenders to finance. P2P lenders are investors first; they watch consumer behavior and market trends across multiple industries to maximize profits. Peer-to-peer lending is revolutionizing the world of personal loans. They are less focused on your financial past and more concerned with the future. The primary thing lenders are looking at is whether or not you will pay back the loan amount on time.
While a good credit score can get you a low-interest personal loan, a P2P installment loan can allow you to pay a fixed monthly payment that can fit your budget.
Title Loan
Title Loans are personal loans that use vehicles as collateral.
If you own your car, motorcycle, RV, or truck, you can put up the title—the paperwork outlining your ownership—as collateral. A borrower can receive a direct deposit loan amount for up to 25% of the car’s value in exchange for that title.
Title loans are no credit check loans that are reasonably easy to get. This means people with different credit scores can usually get approved for these personal loans faster than traditional ones. Title loans are just one quick cash loan option; some can be processed, approved, and sent to your bank account within the same day.
You can repay a title loan in installments or all at once. If you miss any payments, the title loan company may choose to repossess your vehicle and sell it to recoup the money they lost from your loan. This action occurs with most direct deposit loans, but as with any loan, you should always read up on what happens if something goes wrong.
While a title loan might seem like a good idea, they are very risky. No one wants to lose their vehicle. And if it’s the only vehicle you have to get to work or take the kids to school, it’s even riskier. Other unsecured loan options may be better and safer.
Conclusion
A credit card loan is a responsibility that you need to consider heavily before taking it on. Even though it doesn’t behave like your regular credit card debt, a credit card loan will put you deeper into the hole. Before you apply for a new loan, work your budget to find ways to reduce spending to free up some of your income. And if you must borrow, your best bet is to find a low-interest loan with fixed monthly payments that you can afford.
References:
Revolving Credit vs. Installment Credit: What’s the Difference?
The mistake I made while paying off $15,000 in credit card debt — and how to avoid it