Credit Card vs Personal Loan: Which Costs What, and When

A credit card balance is revolving borrowing: no end date, a charge each month on whatever is owed, and a required minimum that is not built to clear it. A personal loan is fixed borrowing: one amount, one tenure, one instalment calculated to reach nil on a known date. The same debt costs very different amounts under the two, even at the identical monthly payment.

From a distance these two look like the same thing wearing different clothes. Both are money that belongs to somebody else. Both produce a figure to pay every month. Both sit on a credit record. So when people set them against each other, they nearly always set one number against another number, the rate on this against the rate on that, and whichever number is smaller is declared the cheaper thing.

The rate-against-rate comparison is not wrong, but it is roughly half of the answer, and the half it leaves out is the half that does most of the damage. One of these two structures schedules its own ending and the other does not, and that single structural fact moves more money than the difference between the two prices does. How much more, to the rupee, works out below on one household's figures, with the monthly payment held identical so that nothing can be blamed on somebody paying more into one than into the other.

Before any of that, both sides get defined in full. A statement balance, a tenure and the way an instalment is arrived at are each built up from nothing, and neither structure is set against a household with a surplus, a buffer or an easy month coming.

The household these figures belong to

Everything worked here belongs to the Bhosale household, invented, in the second of the two years covered. Meghna Bhosale is salaried at Sahyadri Freight Services Private Limited, and her pay did not move that year. Ashok Bhosale runs a tailoring counter in a market lane, and that lane was dug up for drainage work and stayed dug up for five months. The counter took Rs 52,800/- across the year against Rs 96,000/- the year before. Money in fell by Rs 43,200/-, money out stayed exactly where it had always been at Rs 5,51,040/-, and the year finished Rs 20,640/- short. Nobody in that house took a decision that produced any of it.

The shortfall went onto a credit card between September and March, and on 31 March the balance standing on that card was Rs 48,594/-. The Rs 48,594/- is the balance every figure below works on. Two contracted rates sit alongside it, one on the card and one on the loan. The card charges 3.5 per cent a month on the balance once it is not cleared in full, and asks for a minimum of 5 per cent of the statement balance with a floor of Rs 200/-. The loan set beside it is written at 16 per cent a year over twenty-four months.

What is a credit card balance, before anything is compared?

Something easy to picture first. A water-can supplier leaves two cans a week at a door and keeps a running count in a notebook. Take what is needed up to a point I am comfortable with, he says, and settle it when it suits. He has not handed the household any money. He has held open a ceiling. The amount owed at any moment is whatever has been taken and not yet settled, and the amount that can still be taken is the gap between that and the ceiling. Settling part of it opens the gap again.

A credit card is that arrangement, written down, priced, and reported. A card is not a sum of money that arrives. A card is a ceiling that stays open, and the amount owed against it can rise, fall and rise again as often as the household uses it. The Bhosale household's card carries a limit of Rs 60,000/-, which is not money sitting anywhere. The limit is the highest the balance is allowed to go. For two years the household cleared the whole thing every month and the card cost it precisely nothing.

The first thing to hold on to is that a card and a card balance are not the same object. The card is the ceiling. The balance is what is owed under it. A card with nothing owed on it is not borrowing at all. A card becomes borrowing in the first month the whole statement is not cleared, and from that month four mechanical things happen every month, in the same order, without anybody doing anything.

The four things a card balance does every month

One, it charges. Once a balance is carried, the card's contracted rate applies to what is owed. For the Bhosale household that is 3.5 per cent a month, applied to the whole balance rather than to some part of it. On Rs 48,594/- that is Rs 1,701/- added in a single month before anybody has bought anything or paid anything.

Two, it produces a statement. Everything owed as at a particular day is totalled into a statement balance: what was carried in, plus the charge, plus anything spent since. Carrying Rs 48,594/- and spending nothing at all still produces a statement of Rs 50,295/-.

Three, it asks for a minimum. The card names one figure it requires, and for this household that is 5 per cent of the statement balance, so Rs 2,515/- against a statement of Rs 50,295/-. Pay it and nothing goes wrong. Nothing is reported as missed, no late fee arrives, the card keeps working. Keeping the account in order is the entire job the minimum does. The minimum is worked out on the statement, and the statement already includes this month's charge.

Four, whatever is left carries forward, and the loop restarts. Rs 50,295/- less Rs 2,515/- leaves Rs 47,780/-. The remainder becomes next month's opening balance and is charged again. There is no month on any calendar at which this loop is due to stop. The loop stops when somebody stops it.

The loop just drawn is what the word revolvingBorrowing with no fixed end. The balance carries forward month after month and the limit can be drawn again as it is repaid, so nothing inside the arrangement schedules its own finish. means. Revolving is not a description of the rate, and it is not a description of the plastic. Revolving is a description of the shape: a thing that comes back around. The minimum dueThe smallest payment a card requires in a given month to keep the account in order. The minimum is set to protect the account rather than to clear the balance, and those are two very different jobs. is the only figure the arrangement requires. A balance sitting where it is, is exactly the thing the card charges for, so the arrangement is perfectly content for the balance to sit there for years.

The whole definition sits in one paragraph. A credit card balance is borrowing against an open ceiling, priced at a monthly rate on whatever is owed, with a required payment set as a small percentage of what is owed rather than as an amount that clears it, with no tenure, no final payment and no closing date, and with the ceiling free to be used again the moment part of it is repaid. Every property in that sentence matters later on, and the ones that matter most are the properties that are absent.

What is a personal loan, before anything is compared?

Consider a neighbour who lends Rs 12,000/- for a wedding and says, plainly, Rs 1,100/- on the tenth of every month for a year and it is finished. Two things have been fixed in that sentence that were never fixed with the water-can supplier. The amount is fixed, and it will not grow because nothing further can be taken. And the finish is fixed: the twelfth payment is the last one, and everybody knows the date of it on the day the money changes hands.

A personal loan is borrowing where the amount, the price, the number of months and the monthly payment are all settled at the start, and the payment is worked out backwards from the requirement that the balance reaches nil in the last month. The requirement that the balance reaches nil in the last month is the entire machine. The instalment is not chosen for comfort and it is not a percentage of anything. The instalment is solved for. Somebody asks the question: what fixed amount, paid every month for twenty-four months, with interest charged each month on whatever is still outstanding, brings this balance to exactly nil at the end of month twenty-four? The answer to that question is the instalment.

The four things a personal loan fixes at the start

One, the amount. A stated sum is disbursed once. Nothing further can be drawn under it. If Rs 48,594/- is borrowed, Rs 48,594/- is the largest the debt will ever be, and it is the largest on day one. From then on it can only fall.

Two, the rate. A yearly rate is contracted, and for this household it is 16 per cent a year. Interest is worked on the outstanding balance. The balance shrinks every month, so the rupees of interest shrink with it.

Three, the tenureThe number of months a loan is contracted to run for. The tenure is agreed at the start, and it fixes the date on which the debt is scheduled to reach nil.. Twenty-four months here. Tenure is the property the card simply does not have. A tenure is a date, written into the agreement, on which the debt is scheduled to be finished.

Four, the instalmentA loan's fixed monthly payment, calculated so that the balance reaches nil on the last month of the tenure. The instalment is solved for rather than chosen.. On Rs 48,594/- at 16 per cent a year over twenty-four months, that solves to Rs 2,379/- a month. Twenty-three payments of Rs 2,379/- and a final payment of Rs 2,388/- absorb the few rupees the rounding leaves behind, and the debt is gone. Rs 57,105/- has been paid in total, of which Rs 8,511/- was the charge.

Inside each of those identical instalments, something is quietly moving. In month one, interest on Rs 48,594/- at 16 per cent a year is Rs 648/-, so Rs 1,731/- of the Rs 2,379/- goes to the debt itself. By month twelve the balance has fallen to Rs 26,228/- and the interest inside the payment has fallen with it. By the last month the interest is Rs 31/- and almost the whole instalment is repayment. The payment never changes and its composition changes every single month, and that steady shift is what amortisationThe process by which a fixed instalment is split each month between interest and repayment, with the interest share falling and the repayment share rising as the balance comes down. means.

The complete definition sits beside the card's. A personal loan is borrowing of a stated amount, disbursed once and never redrawable, priced at a rate applied to a balance that only falls, repaid by a fixed instalment that was solved backwards from a fixed number of months, ending on a known date whether or not anybody remembers to think about it. The property that matters most here is the one the card lacks entirely: scheduled clearingA debt that reaches nil on a known date if the agreed payments are made, without anybody having to decide to make that happen..

Which of the two has an end date, and what follows from that?

Six things separate these two structures, and the rate is only one of the six. Each criterion comes one at a time below, and the first criterion is the difference that every other difference grows out of.

The loan ends. Not because somebody remembers to end it, not because a household finds a good month, but because the agreement contains a twenty-fourth instalment and there is no twenty-fifth. The Bhosale household has seen that happen once already. The two-wheeler loan it had been paying was thirty instalments of Rs 3,150/-, and in January of that same year the thirtieth instalment went out and the debt was finished. Nobody in the house decided anything. The schedule decided it.

The card does not end. There is no month written anywhere at which the balance is due to be nil. There is a statement each month, a minimum each month, and a balance that goes wherever the month sends it. A fixed borrowing carries its own ending inside it and a revolving one does not. A card balance falls only for as long as somebody keeps deciding to make it fall.

Put like that it sounds like a small administrative difference. It is not. Watch what it does over exactly the same two years, with the same Rs 48,594/-, where the loan is simply paid as agreed and the card is simply paid what the card asks for.

Two years of payments on each. One debt is over. The other has come down by about a third, and it will keep coming down at that pace for another thirteen years. Neither household in that picture did anything wrong. One of them was in a structure that finishes and one of them was in a structure that does not, and that is not a statement about character.

What does each one require each month, and what would clear it?

The second criterion is the one people find hardest to believe, so it is worked slowly, with both figures on the table.

On the card, the required payment in the first month is Rs 2,515/-. The Rs 2,515/- comes from the contracted 5 per cent, applied to a statement balance of Rs 50,295/- that already carries the Rs 1,701/- charged that month. On the loan, the required payment is Rs 2,379/-. The card asks for Rs 136/- more than the loan does, and the loan finishes in twenty four months while the card, on its own required minimum, runs one hundred and eighty three.

The bigger payment is on the structure that takes fifteen years and three months. The size of the monthly payment is not doing the work. The purpose the payment is built for is doing the work.

Opened up, the two payments show where they go.

The mechanism behind that picture is not obvious, and nothing on a statement points it out. The card takes 3.5 per cent of the balance as its charge and then asks for 5 per cent of the statement. The two are worked on almost the same figure, and the charge is added before the minimum is calculated, so what actually reaches the debt is roughly one and seven tenths of one per cent of the balance. The loan takes 16 per cent a year, about one and a third per cent a month, out of a payment of the same size. Everything left over goes to the debt, and everything left over is a much bigger number.

The same mechanism is why the seven months that produced this balance looked the way they did. Between September and March the Bhosale household paid every minimum in full and on the due date, and the balance rose in every one of those seven months. Rs 6,000/- a month of groceries and school costs kept going onto the card while roughly one and seven tenths of one per cent of the balance came off it. Paying the minimum was not falling behind, only keeping up with something that was moving.

What does the same balance cost under each, at the same monthly payment?

Here is the third criterion, and the comparison has to be set up carefully or it proves nothing. If one structure is paid Rs 2,379/- a month and the other is paid whatever it happens to ask for, then any difference in the answer could be a difference in the payment rather than a difference in the structure. So the payment is held identical.

Rs 48,594/- of debt. Rs 2,379/- leaving the household on the same day of every month. Nothing further spent on the card at any point. One version of that story is a personal loan at the contracted 16 per cent a year. The other version is the balance staying exactly where it is on the card at the contracted 3.5 per cent a month, with the household paying Rs 2,379/- because it has decided to, not because anything requires it.

The same Rs 48,594/-, paid the same Rs 2,379/- every month, clears in 24 months as a loan for a total of Rs 57,105/-, and takes 37 months and Rs 86,793/- on the card. Thirteen extra months and Rs 29,688/- extra rupees, with the household paying exactly the same amount on exactly the same day of exactly the same months.

Rs 2,379/- is slightly less than what the card requires in its first four months. The required minimum starts at Rs 2,515/- and falls as the balance falls. Paying Rs 2,379/- is therefore short by Rs 136/- in month one, then by Rs 101/-, Rs 64/- and Rs 27/-, and from the fifth month onward it is comfortably above what is asked. The equal payment comparison is therefore, if anything, slightly generous to the card in its first four months, and it still finishes thirteen months and Rs 29,688/- behind. Paying the card precisely what it asks for every month, which is the only version the agreement itself requires, is the 183 month path.

Look at the fourth row for a moment. The fourth row explains all the others. In the first twelve months both households paid out Rs 28,548/-, to the rupee. One of them removed Rs 22,366/- of debt with it. The other removed Rs 9,904/-. The rest, Rs 18,644/-, went on the price of carrying the balance for a year. Same money out of the same account, and less than half as much debt gone.

One more figure belongs here, and it is the one that carries best when this has to be explained to somebody at a kitchen table. Each month's charge sits on top of the last one, so three and a half per cent a month is not forty two per cent a year. Compounded through twelve months it works out at about 51.1 per cent a year on this household's own contracted figure. The 51.1 per cent is arithmetic performed on one household's own contracted figure, not a rate anybody is offering, and it is the reason the totals in that table are as far apart as they are.

Which one lets a household pay less in a hard month?

The fourth criterion is the one where the card wins outright.

If a month goes wrong, a card lets a household pay less. Not by asking, not by explaining, not by filling anything in. Pay the minimum and the account stays in order. Nothing is reported, nothing is chased, the card keeps working. When the market lane was dug up and the counter took a third of what it used to take, that property is what stood between the Bhosale household and something considerably worse than a balance. There was no month in which anybody had to go and ask permission to pay less.

A loan will not do that. The instalment is Rs 2,379/- in a good month and Rs 2,379/- in a month when a tailoring counter took Rs 900/- all week. There is no smaller version of it. A household that cannot pay it does not pay less; it misses, and missing is a different event with different consequences.

So flexibilityBeing able to pay more or less in a given month without breaching the agreement. A card builds it into the minimum, and a loan has nothing below the instalment. is real, it belongs to the card, and it is worth something that no table can price. And now the uncomfortable half of the same sentence. The permission to pay less in a hard month is the identical mechanical property as the absence of any requirement to pay enough in an easy one. They are not two features. The permission and the absence are one feature, seen from two months.

A loan takes the decision away and a card leaves it with the household every month for as long as the balance exists. Neither of those is a virtue or a vice on its own. The arithmetic above shows that a structure which requires a decision every month will get a decision smaller than the clearing amount in some of those months. Months are like that, and the price of each of those months is added to the balance.

What happens when a payment is missed on each?

The fifth criterion, and the two structures behave quite differently here. The difference surprises people who assume a missed payment is a missed payment.

On the loan there is a schedule, so there is something to fall behind. A missed paymentA payment not made by its due date. On a scheduled debt it becomes an arrear against a dated instalment; on a revolving one there is no schedule for it to be an arrear against. becomes an arrear against a specific dated instalment, the agreement's own charges for late payment apply, and the loan is now behind by one instalment in a way that has to be caught up rather than absorbed. The tenure was built on twenty four payments arriving on twenty four dates. Take one away and the structure has to be repaired.

On the card there is no schedule, so there is nothing to be behind. The agreement's late payment charge is added instead, the balance is larger next month than it would otherwise have been, the larger balance is charged at the contracted rate, and the loop simply turns again around a bigger number. Nothing was broken because nothing was scheduled. A missed loan payment damages a plan, and a missed card payment quietly enlarges a balance, and the second one is easier to not notice for a very long time.

The part households most often do not expect is the same on both: both are reported. The credit information companies receive the record either way. A payment reported as missed is a fact on the record about the past, and no later payment removes it. Charges, penalty figures and timelines for any of that belong to the agreement itself and to the conduct rules named among the references below.

What does each one do to a credit record?

The sixth criterion, and the two lines look nothing alike to whoever is reading them later.

A card appears on the record as a revolving line with a limit attached, so it carries a figure a loan cannot have: utilisationHow much of a credit limit is being used, written as a percentage. Utilisation exists only where there is a limit, so revolving lines have it and instalment loans do not., being how much of the ceiling is in use. On 31 March the Bhosale household's Rs 48,594/- sat against a Rs 60,000/- limit, so 81.0 per cent of the ceiling was in use. Utilisation moves every month with the balance, and it moves without anybody borrowing anything new. The charge alone pushes the balance up.

A loan appears as an instalment line with an original amount, a tenure, a payment history and a balance that is expected to fall. There is no ceiling for a percentage to be taken of, so there is no utilisation on a loan. A loan halfway through its tenure looks exactly like what it is: a debt being repaid on schedule.

The same rupees of debt therefore present very differently: as a card balance they present as a ceiling being used up, and as a loan they present as a schedule being kept. Scoring ranges, weightings and cut offs are not published facts. The Bhosale household's own record moved: a score of 712 at the start of the year and 664 at the end of it, tracking a utilisation that climbed and one instalment on a separate arrangement reported forty days late. How records are built, what they may contain and how an entry is disputed sit with the credit information companies and with the Reserve Bank of India at rbi.org.in.

How a lender actually reads these two lines

The practitioner's half of the subject is worth knowing outside a lending office as much as inside one. When somebody assesses a household later, they are not reading a moral history. The assessment is two arithmetic operations.

The first operation weighs the household's committed monthly payments against its earnings. At 31 March, with the two-wheeler loan finished, the Bhosale household's card payment of Rs 2,558/- and its Rs 4,000/- instalment on a separate arrangement came to Rs 6,558/- a month. Against net monthly income of Rs 44,200/- that is 14.8 per cent, and against gross monthly income of Rs 50,400/- it is 13.0 per cent. Two numbers, nearly two points apart, from the same household in the same month. Anybody quoting a ratio should say which income they used.

The second is the shape of the lines themselves. An instalment line that ends on a known date is a commitment that is visibly shrinking. A revolving line at 81.0 per cent of its ceiling could be anything next month. The household can draw on it again, and the charge lifts it without any drawing at all. Assessors read those two differently. How much differently is not knowable from outside, and it sits inside models nobody publishes.

Where does comparing the two on their rates go wrong?

When is each of these the thing a household is actually holding?

Everything above compares the two as though somebody sat down with both on the table and picked one. The comparison is worth understanding, and it is not how most people arrive at either.

A loan is nearly always a decision. Somebody applies, somebody assesses, a figure is agreed, papers are signed and money lands on a date. There is a moment, and in that moment a choice was made about an amount and a tenure.

A card balance is very rarely a decision. A card balance is what is left at the end of a month. The Bhosale household did not weigh a card balance against a personal loan in September and select the card. The lane was dug up, the counter took less, the account was low near the end of the month, and the groceries and the school costs went on the card because that is what was available at the till on a Tuesday. By March, seven ordinary months later, that had become Rs 48,594/-. A card balance is usually the result of a month rather than the result of a choice. For most of the people holding one there was no decision to have made.

Which of them a household should hold, or move to, or apply for depends on things no comparison can see: what is actually on offer to a particular household, what a month actually looks like, what happens if the flexible option is removed, and what else is owed. All six criteria matter here, not one, and the difference between a payment that is larger and a payment that finishes is plain whenever both structures are set side by side.

One last point belongs to anybody holding a balance right now. Knowing this arithmetic and being able to act on it are separate things. The distance between the two structures is enormous, and the distance between paying the minimum and paying anything at all above it is larger still. Where there is no room, there is no room, and any suggestion otherwise would be untrue. Where there is a little room, the first rupees above the minimum do more work than any other rupees in this entire subject.

The Bhosale household, Meghna Bhosale, Ashok Bhosale, Ira Bhosale and Sahyadri Freight Services Private Limited are invented.
Educational material. Not advice on any investment, tax, budget or market position.