As the cliché goes, life can be unpredictable. It can throw surprises that can affect you, financially-speaking. It is recommended that you have access to emergency fund to cover for those unexpected emergencies, such as car repair or health concerns. There are two common ways to access funds that are available for those who find themselves in a similar situation. These two options are a personal line of credit and personal loans. Many consumers confuse them with each other but these are actually two different things.
Take time to learn about the differences between a personal line of credit and a personal loan.
Personal Line of Credit vs Personal Loan
As already mentioned, personal line of credit is not the same with personal loan. There are certain pros and cons associated with each one that can help you decide the best fit for your needs. You can learn more about each of them below:
- Personal Line of Credit – A line of credit is provided to an individual by a bank or financial institution. All individuals applying for this type of funding must have a checking account within that particular bank or institution. Once approved, you will be given access to a certain amount of money to use on whatever purpose you intend. You will have to pay back that amount (with interest) to the bank. There are two types of personal line of credit: secured or unsecured. The secured line of credit requires you to offer a collateral while the latter does not. A common type of secured personal line of credit is a home equity line of credit.
- Personal Loan – A personal loan is a lot like the line of credit in the sense that it is provided by banks and financial institutions. However, you might be required to state your purpose for the money upon application. Some of the common reasons for acquiring personal loan are to consolidate debt, handling unexpected bills, medical emergencies, and so on. Upon approval, you will be issued the amount of money you applied for. You will also be given a fixed period of time for you to repay the amount.
While personal line of credit and personal loans might appear similar, there are key differences with each that you must know about. Knowing what these differences are could help you decide on the right option for your needs:
- Interest Rate: One of the things that make a personal line of credit different from a personal loan is that the former is revolving. For instance, you can get access to a certain amount of money once you have repaid the previous amount that you owe. Depending on the amount that you borrow for a certain period of time, it will come with a variable interest rate. When you apply for a personal loan, you can get a fixed interest rate. The interest rate is calculated based on financial history and credit score. If you want to have a specific amount of money allotted each month for your expenses, a personal loan might be the best option.
- Lump Sum vs Access to Cash: This is another major difference between these two types of funding. A personal line of credit will provide you with a maximum credit amount. You can have access to the fund but it will not be automatically deposited to your account. On the flip side, personal loans are given to you in full. For instance, when you apply for a specific amount, you will get the amount upon approval. You can use that money to cover for any expenses or debts that you might have.
- Fees: The fees in question here is different from the interest rate. It is important to know the difference as it will affect how much money you need to repay the bank or financial institution. A line of credit will have a varying APR and you will have to pay other fees as well (such as inactivity or transaction fees). On the other hand, personal loans have a fixed interest. Your monthly payment for that loan is therefore fixed. Any charges will be asked upfront so you won’t have to cover any other fees, except if you are unable to repay the loan within the agreed time period.
How to Choose
Knowing the difference between a personal line of credit and a personal loan, you are now in a better position to choose the right type of loan to pursue. You can consider the following circumstances wherein each option would align with your needs.
You can get a personal line of credit if any of these applies to you:
- To fund home improvement or repair projects
- To cover for emergency expenses
- To supplement irregular income
You can get a personal loan if any of these applies to you:
- To pay off credit card debt
- To finance a large purchase
- To pay off student loans
Both types of funding options will require you to pay back the amount of money you owe with interest. However, you will be free from other charges and fees such as annual fees that most credit cards have. An important thing for you to know is that the interest might be higher on personal line of credit than your average credit card. This is mostly due to the fact that a line of credit is a greater risk for the financial institution. Depending on your borrowing needs, this could be worth it. You have to make sure that you repay the amount within the agreed period of time to avoid incurring extra fees and charges.
If you are still unsure, most banks and financial institutions offer credit evaluation. You can take advantage of this service to help decide the best option to match your financial needs. Finance professionals will be able to provide expert insights to your financial situation. The more educated you are about each option, the more you can proceed with confidence knowing that you have access to funds you need now. Plus, you can be confident that you will be able to repay the money you owe later.
Robert is our in-house expert on personal loans and finance. He got an MBA, specializing in Finance, before joining the workforce. After working for multiple Fortune 500 companies in the past decade, he brings a wealth of knowledge and experience to the table.