What’s the difference between a personal loan and personal line of credit?
When you have an unexpected expense or just want to improve your credit profile, a personal loan or a personal credit line can let you borrow the money you need to meet your goals. However, both of these financing options work in very different ways and strategic borrowers must carefully weigh which one would work best for their situation.
Unlike a mortgage or car loan, personal loans don’t traditionally require any collateral. Although some lenders do offer secured personal loans – a type of financing that allows you to put up collateral in exchange for a lower interest rate. When accepted for a personal loan, you receive all of the cash up front to use as you wish.
Personal loans are commonly issued with a fixed term, generally between one and seven years. A fixed term ensures the same fixed monthly payment for the duration of your loan, at an interest rate you can agree on. However, some lenders offer personal loans that have variable interest rates if that is what you prefer. Rates for personal loans can range from 5 to 36 percent. Personal loan interest rates are generally lower than interest rates for personal lines of credit because there is less lender uncertainty. The lender knows precisely how much you are borrowing and when you are scheduled to pay it back.
Personal Line of Credit
A personal line of credit uses a revolving credit system, similar to your credit card. This type of financing doesn’t require collateral such as a home or car title. However, instead of swiping a piece of plastic you will transfer the funds from your line of credit into your bank account and use a line of credit check or an in-branch advance to receive the funds.
Similar to a credit card, you will be able to borrow money against your line of credit as needed, as long as it is within your granted limitations. Depending on the terms of your line of credit and the balance owed, you’ll make different monthly payments. Your monthly minimum payment on your personal line of credit may be a fixed amount, such as $30, or a percentage of the owed balance, plus fees, interest, and other charges. A personal line of credit’s interest is typically variable, which paired with the fluctuating amount owed, makes monthly payments less predictable than other financing options. The interest rates on a personal line of credit typically range between 5 and 20 percent.
Which one is best for me?
If you know the amount of money that you need and you won’t need funds in the future, a personal loan is a more favorable choice. Since you don’t require the flexibility of a line of credit, you save money by avoiding the higher interest associated with that type of financing.
Consider a personal loan for:
- Consolidating debts
- A strict wedding budget
- Home improvement projects with a known budget
- Major car repairs
- An unexpected tax bill
- Medical bills
A personal line of credit is the best choice for those who need access to funds on a recurring basis, rather than a single payment of one lump sum. If you are self-employed or work on commission, you may be familiar with working on a variable income. This type of financing can help ensure stability during lower-income months and allow you to repay the debt during high-income months. Personal lines of credit are also great for projects that don’t have a total defined cost. With this type of credit, you can acquire funding as you need it.
Consider a personal line of credit for:
- Those with variable incomes
- Projects without a strict budget
- Periodic access to financing