So, you’re interested in talking about interest? All bad jokes aside, interest is a tricky subject for many. We know we’re supposed to care about it, but we’re not entirely sure why. The fact is that interest, much like oxygen and cute cat videos, is everywhere. Interest rates influence the return on your savings, the overall return on many investments, and—most notably for today’s topic—the cost of borrowing money.
At a glance, credit cards and personal loans have more in common than offering a way to borrow funds. In both credit card and loan agreements, you’ll be offered money at a specified interest rate, have monthly payments that factor in both the original loan amount and the accumulated interest, incur late fees for missed payments, and run into amount limits, underwriting requirements, and more.
Taken at face value, it looks like personal loans and credit cards are practically the same. However, digging a bit deeper uncovers something of interest (sorry, we had to!).
Is Personal Loan Interest the Same as Credit Card Interest?
The short answer? No! The long answer? Though they seem similar, the key to differentiating between them is understanding the difference between simple and compound interest rates.
Simple Interest
Simple interest is, well, simple. It’s a percentage predetermined by a lender that considers the initial (or principal) amount of a loan and how long you have to repay it (i.e., the repayment period). Simple interest is the kind of interest seen in most personal loans.
Compound Interest
Compound interest is also aptly named. Essentially, you can think of compound interest as “interest stacked on top of interest.” It is the kind of interest most credit cards have. Here’s how it works: when your card first gains a balance, an initial percentage is applied to that amount. Then, additional interest is added to the previously accrued interest amount on a recurring, daily basis. The longer it takes for you to pay off, the higher your balance will climb as interest begins to add up.
So, Is That It?
At a basic level, the difference between credit card interest and personal loan interest can be distilled down to the difference between compound and simple interest. Before you decide which one is right for you, however, there are several other factors that influence the interest rates of both that need to be discussed.
Credit Card Interest
The most significant difference between credit card interest and personal loan interest is that technically, credit card interest doesn’t need to be paid at all. Yes, you read that right! Granted, this hinges on a cardholder paying their entire monthly balance on time, but doing so results in no interest charged on their account balance in the first place.
In a perfect world, everyone would be able to pay off their credit card balance all at once. But realistically, many cardholders won’t be in the financial position to pay their balance in full between the statement’s posted date and its due date. This means that the compounding interest will be applied to the original balance. Once this happens, you’d have to pay off the entirety of the new balance to avoid accruing further interest.
It’s also important to note that different credit card transactions, such as balance transfers, cash advances, and purchases, can be subject to their own interest rates.
Personal Loan Interest
When someone accumulates a credit card balance, there can be wiggle room regarding how they pay it off. Meanwhile, a personal loan is much more structured when it comes to repayment. After an applicant is approved for a personal loan, the lender provides them with a pre-established repayment plan. This plan takes the form of monthly installments that will be paid each month over the loan’s length (or term).
Here’s where interest comes into the picture: For most personal loans, the interest (in addition to any other fees and costs) is calculated as an annual percentage rate (APR). The APR is applied to the initial loan amount. The resulting number represents the overall amount the borrower will pay back to the lender. This figure is then divided by the loan term, resulting in the monthly installments we talked about earlier.
The good news is most personal loan APRs will not change over the term of the loan. This fixed rate means the monthly payments will always be predictable and easy to manage. Additionally, the interest is calculated and applied to the loan balance only once, right at the beginning of the loan process, rather than daily like credit card interest.
What’s Right for Me?
Credit cards and personal loans are usually used for different reasons, and, as a consequence, interest functions differently for both. Depending on your financial situation and credit history, you might find a personal loan with a lower interest rate than a credit card. But before you sign on the dotted line, make sure you know all the specifics of your loan or credit card. In particular, pay attention to:
- How the interest rate is determined
- What hidden fees and costs come with it
- What the consequences are for missing a monthly payment
Ultimately, whichever option you choose should best fit your unique financial needs, help you accomplish your goals, and above all, pique your interest (that’s the last one, we swear!).
If you need additional support in choosing between a credit card and a personal loan, Credit Direct is here to help! Whether you’re buying a new car, remodeling your home, paying off an unexpected bill, or consolidating debt, our loan agents can help you determine the right path for your needs. And, as a bonus, Credit Direct allows you to view your customized loan offers before accepting one, giving you all you need to make an informed decision. Check your rate in minutes with no effect to credit score!