Personal Loan vs. Line of Credit: How to Choose

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  • Personal loans and lines of credit are two ways to raise cash for just about any purpose.
  • A personal loan pays you the full amount up front and can be good if you know how much you need.
  • If you want to use cash as needed and are unsure of the total amount, a line of credit may be best.

There are all kinds of loans tailored to specific needs in life, such as: B. financing your studies, financing a new car or buying your own home. If you need money for reasons that don’t fit into any of these specific categories, a personal loan or line of credit can be a good option.

“Personal loans and lines of credit both offer two different ways to achieve the same end goal—borrowing money,” says Dani Pascarella, a CFP® professional and founder of OneEleven Financial Wellness.

You can use the money from a personal loan or line of credit for almost anything.

Personal loan vs. credit line: at a glance

While both options are available when you need to borrow money, there are key differences in how personal loans and lines of credit are obtained and used.

  • Personal Loans are flat-rate installment loans that you can use for any purpose, e.g. B. paying for an emergency expense, a home appliance, or even for debt consolidation.
  • lines of credit You can borrow and make payments on an ongoing basis. You can borrow up to the maximum amount that your credit history allows you to borrow.

What is a personal loan?

With a personal loan, you receive the approved amount in one sum and then pay monthly until the full payment is made. These payments include the principal or the amount you borrow along with interest.

When applying for a personal loan, the following points should be considered:

  • Credit and Income Requirements
  • Interest charges
  • Fees (if any)
  • Conditions including how long you have to pay it back

“A personal loan makes sense if you know how much money you need to borrow,” says Pascarella. “Borrowers like this approach because there is a clear end date by which that debt will be paid off in full, and the fixed monthly payments make it easy to fit the loan into the household budget.”

Personal loans are usually unsecured, which means that the most important factor in approval is your credit rating. The better your credit score, the more likely you are to be approved at the lowest interest rate available. Borrowers with poor and fair credit may find it more difficult to obtain approval and if they do, it may result in a higher interest rate.

If you are having trouble qualifying for an unsecured personal loan, there are some banks that offer secured loans. Secured personal loans are backed by collateral like other types of secured loans, but personal loans are a little different. They are backed by your savings accounts or Certificates of Deposit (CD). Your loan is usually a percentage of your account balance, set by the bank or financial institution you’re working with.

Interest rates on personal loans are usually lower compared to lines of credit, but it depends on your creditworthiness and how responsible you are as a borrower to demonstrate that you should be getting the lowest interest rate on offer.

When is a personal loan better than a credit line?

A personal loan might be better than a line of credit if:

  • You know exactly how much you need. If you have a specific goal in mind, such as Whether it’s buying a new device or paying off an outstanding medical debt, a personal loan could be what you need to help you cover your expenses.
  • You want to make consistent monthly payments. Personal loans usually have fixed interest rates, which means you pay the same amount every month for the life of the loan. If you’re on a tight budget with very little room to maneuver, a personal loan might be a better option.
  • You consolidate debt. If you have a lot of outstanding debt with high interest rates, you can consolidate it with a personal loan. You borrow the full amount you want to pay back. When you receive the money in one lump sum, you pay off all of your debt and then make a single monthly payment to your new lender.

Example of a personal loan

Let’s say you’re planning a wedding reception and the venue requires half the cost up front. While you may have saved a little for your big party, you may not have enough to cover the large, one-time expenses. You can take out a personal loan to cover the venue deposit and then make manageable monthly payments to pay it back.

What is a line of credit?

A line of credit is a flexible financing option you can use when you need revolving access to cash.

With a line of credit, your lender determines the maximum amount you can borrow. Then you can borrow as little or as much as you need, up to the maximum. In most cases, paying the balance in full by your monthly due date can help you avoid paying interest. You must make minimum monthly payments to stay in good standing. You only pay interest on the amount borrowed – not the full approved amount.

Most lines of credit are unsecured, which means you don’t need collateral. A credit card is a good example of this. Lenders use your credit history, credit rating, and other factors to determine how much you can borrow and at what interest rates. Some lines of credit, such as B. Home Equity Lines of Credit (HELOCs), however, are secured using your home as collateral.

Personal lines of credit have a drawing period during which you can borrow and begin making payments as needed. Then there is a repayment period during which you cannot take out any more credit until the balance is paid in full. Credit cards allow you to borrow up to the maximum amount you are authorized to borrow. When you reach this limit, you cannot borrow more until you make payments that reduce the principal balance.

“If you’re looking for flexibility with your loan size, when you borrow, or your repayment schedule, a personal line of credit is a great choice,” says Pascarella. “You can also pay off the debt in your desired time frame as long as you meet the minimum monthly payments.”

When is a credit line better than a personal loan?

A line of credit makes sense if:

  • Not sure how much money you need. If you have a vague idea of ​​how much to borrow but think you may need more, a line of credit gives you the ability to use more when you need it.
  • You can pay in full. Interest rates on personal lines of credit and credit cards tend to be higher, on average, than personal loans. Interest rates are applied when you keep a balance from month to month. So if you pay off your balance in full by the due date, you can essentially borrow interest-free.
  • You want to use it for the long term. Credit lines can be held for many years. With personal lines of credit, that can be around 15 years, while you can have credit card accounts for decades. If you want to be able to draw on the account for many years, a credit line is a better choice.

Example of a line of credit

Let’s say you’re getting married and your florist and caterer need a down payment for the big day in addition to a large down payment for the venue. Since many expenses come up at once – and some you’re not sure about – you can use a personal line of credit to get money into your bank account and make your deposits on time.

You can also use a credit card to cover minor expenses during the wedding planning process or to make a large purchase with generous cashback offers. For example, you can use a travel credit card to book the honeymoon and get a free flight through the points you earn.

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