Personal Loans vs credit cards: what’s your best option?

The term "personal loan" encompasses many different types of products with different names, all designed to perform a similar function.

The early days of personal loans saw little choice available to consumers, with most loans having similar interest rates, fees and conditions. These days, personal lending has evolved, giving borrowers more choice about what to spend their loan money on. Unsecured loans like holiday loans, debt consolidation loans, home improvement loans, and secured loans such as car loans all now fall under the personal loan banner.

However, in this age of 'plastic money', credit cards are beginning to compete with the personal loan for many smaller or medium-sized purchases. With competition fierce among lenders, credit card fees have been slashed, with many credit card interest rates rivalling those of the traditionally lower rates found in personal loans. Where credit card interest rates have dropped substantially over the last couple of years, personal loan interest rates have not, remaining relatively static in comparison.

But what about the larger purchases, such as a car, motorcycle or boat? Many merchants will not accept a credit card in payment for such a major expense and this is where personal loans still hold their own.

Personal loans vs Credit cards

Aside from the obvious name changes designed specifically for particular purchases, personal loans have had to make certain changes to compete in the ever-expanding personal finance market. Immediate loan approvals, redraw facilities designed to compete with credit card cash advances, flexible repayment options and lower fees all combine to make the average personal loan more attractive than it was in the past.

One problem with credit cards that’s not immediately apparent is that of 'easy money,' where funds are available constantly. This can be problematic for many consumers who have difficulty controlling their spending habits and end up much further in debt than they originally intended. Purchases made with a personal loan, on the other hand, tend to be premeditated, taking away the temptation to spend more than you can afford.

One important area where personal loans and credit cards now compete is in debt consolidation. Debt consolidation is particualry popular after the Christmas period, when spending limits have been stretched. Consumers now have a choice between a debt consolidation personal loan, or credit cards offering low interest or 0% balance transfers for up to 6 months on balances rolled into the credit card.

The future of personal loans

With a sharp rise in credit card applications in recent months, it may seem as if personal loans are in the early stages of extinction. But is this the case?

According to the credit agency Baycorp Advantage, the July to September quarter of 2006 showed a marked increase in applications for personal loans. Compared to the same period of the previous year, applications rose by a substantial 6.7%. Good news for the future of this dinosaur of financial products.

Continued evolution is essential to the personal loan if it wishes to remain in existence and compete with the flexibility offered by the credit card companies. Redraw facilities need to be developed and improved and consumers need to be offered greater flexibility in their repayment options and schedules. A lot of movement has already taken place in this direction, and if it persists, the personal loan will no doubt continue to have an important place in Australia’s personal lending market.