Loans on Credit Card: When Does it Make Financial Sense?

In today’s fast-paced world, efficient financial management has become crucial. Credit cards, often seen as a tool for short-term borrowing or earning rewards, offer more than just a convenient way to pay for goods and services.

Some credit cards offer an option known as a loan on credit card or credit card loan. This can be a quick solution to financial emergencies, but it’s important to understand the intricacies before committing to it.

In this article, we’ll take a closer look at how credit card loans work, when they make sense and the risks involved.

What is a Loan on a Credit Card?

A Loan on a credit card refers to the ability to borrow money against the available credit limit, usually in the form of a cash advance or personal loan offered by the card issuer. Unlike regular credit card purchases, where you can maintain a balance and pay it off over time, a credit card loan usually comes with higher interest rates and possibly additional fees.

There are two main types of credit that can be taken out with a credit card:

1. Cash Advances: With a cash advance, you can withdraw cash from an ATM or get a cheque drawn on your credit card account. These loans usually carry higher interest rates than regular purchases, and interest accrues immediately, with no grace period.
2. Personal loans via credit card: Some credit card issuers offer the option of taking out a personal loan via your credit card, which can be used for any purpose. The amount borrowed is credited to your balance and you repay it in fixed monthly instalments over a set period of time. While these loans have lower interest rates than cash advances, they often come with additional fees.

How Do Loans on Credit Cards Work?

Loans on credit cards work differently depending on the type of loan you take out. Here’s how they usually work:

Cash advances:

1. You can withdraw cash from an ATM or bank branch, or use a cheque linked to your credit card.
2. The amount borrowed is credited to your credit card balance and interest begins to accrue immediately.
3. There is no grace period for cash advances, which means you pay interest from day one.
4. In addition, cash advances often come with fees, such as a flat fee or a percentage of the amount borrowed.

Personal loans via credit cards:

1. Many credit card issuers allow you to convert a portion of your available credit into a personal loan.
2. You usually have to apply for such a loan, and if approved, the loan amount will be offset against your credit card balance.
3. The interest rates on these loans are usually lower than cash advances, but still higher than traditional loans from banks or credit unions.
4. Repayment is usually made in fixed monthly instalments over a fixed term, e.g. 12, 24 or 36 months.

Advantages of Loans on Credit Cards

1. Quick and easy access to funds: A credit card loan can provide quick access to funds, often without additional paperwork or approval procedures, especially if it’s a cash advance.
2. Flexible use of funds: Unlike other loans that are tied to specific purposes (e.g. car loans, home loans), a credit card loan can usually be used for any personal need, from emergencies to consolidating high-interest debt.
3. No collateral required: Credit card loans are unsecured, meaning you don’t have to put up collateral (such as your home or car) to borrow the money.
4. Convenience: You don’t need to apply for a separate loan or visit a bank. Simply use the functions of your credit card to access the loan – a convenient option for urgent cases.

Disadvantages and Risks of Loans on Credit Cards

Credit card loans may sound tempting, but they come with considerable risks and disadvantages that need to be carefully weighed up:

1. High interest rates: Interest rates on credit card loans are often much higher than traditional personal loans. For cash advances in particular, APRs can exceed 20-25% and are usually higher than the normal APR on your card.
2. No grace period for cash advances: Unlike regular credit card purchases, which have a grace period (usually 21-30 days), cash advances accrue interest immediately. This can cause you to quickly accumulate debt if you don’t repay it off quickly.
3. Additional fees: Most cash advances on credit cards come with fees, usually ranging from 3% to 5% of the amount withdrawn. These fees can quickly add up, making the loan much more expensive than it seems at first glance.
4. Impact on credit score: Taking out a loan on your credit card increases your credit utilisation (the percentage of your available credit that is used), which can have a negative impact on your credit score. High credit utilisation can lower your credit score, making it more difficult to obtain other loans or credit in the future.
5. Debt spiral: Due to the high interest rates and fees associated with credit card loans, it’s easy to fall into a debt trap. If you don’t make regular payments or don’t pay off the loan within a reasonable amount of time, the debt can quickly skyrocket.

When Should You Consider a Loan on Your Credit Card?

While credit card loans can be a convenient financial tool, they should only be considered in certain situations. Here are some scenarios in which borrowing on your credit card may make sense:

1. Emergency expenses: If you’re faced with an unexpected medical bill or car repair and have no other sources of funding available, a credit card loan can provide quick cash.
2. Debt consolidation: If you have high-interest debt on other cards or loans, consolidating that debt into a personal loan through your credit card can be a low-interest alternative.
3. Short-term borrowing: If you are sure you can repay the loan quickly, you can use your credit card for a short-term loan to save yourself the hassle of applying for a traditional loan.

However, you should generally avoid using credit cards for loans unless absolutely necessary. Conventional personal loans from banks or credit unions usually offer lower interest rates and better repayment terms.

Read More:

• 9 Proven Ways to Pay Off Debt Faster and Stress Less About Money
• UPI vs. Credit Card: Which is Better?

Alternatives to Loans on Credit Cards

Before you decide on a credit card loan, you should consider these alternatives, which may offer better conditions:

1. Personal loans: often with fixed interest rates and more favourable terms than credit card loans.
2. Home equity line of credit (HELOC): If you own a home, a HELOC may offer a lower interest rate by leveraging the equity in your property.
3. Peer-to-peer lending: Online platforms that match borrowers with individual lenders, often offering favourable interest rates.
4. Debt consolidation loans: Specifically designed to consolidate multiple debts into one loan with a lower interest rate.

Can I Put Student Loans on Credit Card?

No, you cannot put student loans directly on a credit card. Credit institutions for student loans generally do not accept credit cards as a means of payment. However, there are a few workarounds:

1. Third-party payment services: some services act as an intermediary and allow you to pay your student loans with a credit card. However, these services usually charge a fee, which can be expensive.
2. Balance transfers: You can transfer the balance of your student loan to a credit card with an introductory APR of 0. This can be a good option if you can pay off the balance before the introductory period ends. However, be aware of balance transfer fees and potentially high interest rates after the introductory period.
3. Cash advances: You can take a cash advance on your credit card and use the money to pay off your student loans. However, cash advances usually come with high interest rates and fees.

Can Income Tax Be Paid by Credit Card?

Yes, in India you can pay income tax using a credit card. The Income Tax Department offers an online payment portal that accepts credit card payments. This allows taxpayers to conveniently pay their taxes online using their credit card. However, it should be noted that some credit card companies may charge a transaction fee for these payments.

Final Thoughts

While credit card loans offer quick access to cash and are a useful tool for emergencies, they also come with risks such as high interest rates, fees, and the potential to hurt your credit score.

It’s important to carefully consider your financial situation, repayment options, and other available options before taking out a credit card loan. Always consider alternatives such as personal loans or other credit products that may offer lower interest rates and more favourable terms.

If you decide to take out a loan on your credit card, you should have a clear repayment strategy to minimise the financial burden in the long term.