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Personal loans typically have lower interest than credit cards if you have good credit, but may have a higher rate for those with poor credit. Personal loans and credit cards also display their interest rates and charge interest in different ways.
Understanding the difference between the interest rate you see on credit cards and loans can help you find the least expensive form of financing. Read on to learn more.
What Is the Difference Between Credit Card Interest and Loan Interest?
The interest rate on your credit card or loan can influence how much you'll pay in financing charges when you borrow money. However, interest works differently with credit cards and personal loans.
Credit Card Interest
With credit cards, the interest rate is displayed as an annual percentage rate (APR), but the terms are used interchangeably. Different credit card transactions, such as purchases, balance transfers and cash advances, can have their own APRs. Fees, such as a card's annual fee or its balance transfer fee, don't get factored into the APR.
Credit cards are a form of revolving credit, meaning you can borrow against your credit line and repay it quickly or "revolve" it to the next month (with interest). Fortunately, many credit cards offer a grace period, which means you won't pay any interest on purchases if you pay your purchase balance in full each month. You can lose this perk, however, if you carry a purchase balance from one month to the next, or you have a balance transfer or cash advance balance.
Many credit card companies determine the interest you'll pay by dividing the APR by either 360 or 365 to determine your daily periodic rate. That rate then gets multiplied by the related interest-accruing balance each day, the result gets added to your balance, and the same process happens the next day. Your monthly credit card statement will show you how much interest you've been charged for that statement period.
Personal Loan Interest
A personal loan's interest rate won't necessarily be the same as the loan's APR. With loans, the APR includes the loan's interest rate and fees the lender charges, such as an origination fee. As a result, loan APRs are often higher than their interest rates. It's also why you want to compare APRs, as they can give you a better sense of what you'll actually end up paying.
A personal loan is an installment loan, so you'll receive the loan amount right away and then repay it in regular payments, or "installments." Interest will start to accrue on your loan from the start, but monthly payments on many loans go toward paying down the loan balance as well as the accrued interest, a practice known as amortization. Initially, most of your monthly payment will go toward interest, but as time goes on and interest charges are paid down, most of your monthly payment will go toward paying the principal loan balance.
How Your Credit Score Impacts Your Interest Rate
For both credit cards and personal loans, your credit score when you apply can affect the interest rate you'll be offered on your account. Having a higher score can help you get a lower rate, which will save you money.
The most extreme example of money-saving you can realize is on a mortgage, as the large loan amount and long repayment term means even a slight change in your interest rate can drastically change what you'll owe.
Based on a FICO® calculator, the total amount of interest you might pay on a 30-year, $300,000 mortgage can range from $154,867 (if your score is in the 760 to 850 range) to $252,430 (if your score is in the 620 to 639 range). Having poorer credit could increase your monthly payment by about $300, and lead to paying an extra $97,000 in interest over the lifetime of the loan.
While the impact won't be as extreme with a personal loan or credit card, your credit score will still affect the rate you receive. Additionally, most credit cards and some personal loans have a variable rate, which means the interest rate may rise or fall after you open your account.
What's a Good Interest Rate for a Personal Loan?
A good personal loan rate is in the mid-single digits (for example, around 6% APR). However, many personal loans have an APR range, and only the most creditworthy applicants will qualify for the lowest advertised rate. You can sometimes get an estimated loan offer from a lender by applying for a loan prequalification with a soft inquiry, which won't impact your credit.
Reviewing multiple personal loan offers can help you find the lender that will likely offer you the lowest rate before applying. Submitting the loan application could result in a hard inquiry, which may hurt your credit a little temporarily.
How to Choose a Credit Card With Low Interest
Similar to personal loans, many credit cards also have an APR range. If you're comparing credit cards, you can look at the APR ranges to see which cards might offer the lowest rate. But the APR you receive will depend on your creditworthiness.
Also, remember, credit card APRs don't take fees into account. To determine which card may be least expensive for you, also compare the cards' annual fees and usage-based fees, such as balance transfer, cash advance and foreign exchange fees.
You can also narrow down your search by focusing on low rate cards. These tend to have fewer benefits and rewards than other credit cards, but a lower APR can save you money if you can't pay your bill in full each month. Credit cards from credit unions may be a good choice, as the National Credit Union Administration (NCUA) caps credit card interest rates at 18% APR. Credit cards from other issuers may have APRs in the mid- to high-20s.
Some credit card companies also offer cards with an introductory interest rate, such as 0% APR, during a promotional period. Card issuers also occasionally offer existing cardholders a temporary lower rate, and you can also call your issuer and try to negotiate a lower interest rate on your card if your credit situation has improved since you opened your account.
Finding the Least Expensive Option
Depending on your credit and financial situation, you may find a personal loan with a higher or lower interest rate than a credit card. But that's only part of the picture. Consider the fees involved with both financing options and how the creditors charge and collect interest.
If you want to compare offers, you can use a tool like Experian CreditMatchTM for personal loans and credit cards. After signing up, you can see matches based on your credit score, and using the service won't hurt your credit.