A personal line of credit and a personal loan both allow you to borrow money for almost anything your heart desires. However, they work in very different ways. Here’s what you need to know if you’re trying to decide whether a line of credit or personal loan would work better for your situation.
What is a Personal Line of Credit?
A personal line of credit is a type of revolving credit similar to a credit card. In most cases, a personal line of credit doesn’t require any collateral, such as a car title or a home with equity. Rather than having a piece of plastic you insert or swipe to use your credit, you’ll usually transfer funds to a bank account, get an advance at a branch or use line-of-credit checks to access your line of credit.
Like a credit card, you’ll be able to borrow money against your line as often as needed as long as you don’t exceed the limit on the line of credit you’ve been granted. You’ll have to make payments that vary depending on the balance owed and terms of your line of credit. Typically, your minimum payment will be whichever is greater of a predetermined amount, such as $25, or a percentage of the balance owed, such as 1%, plus any interest, fees or other charges.
The interest rate on a personal line of credit is usually variable, which along with a varying balance owed makes its payments less predictable than those with a personal loan. The interest rates on lines of credit are often higher than the interest rates on personal loans, ranging between 5% and 17% above the Prime Rate. Some lenders allow you to put up collateral if you’d like to obtain a lower interest rate. Additionally, many lines of credit charge an annual fee to keep the credit line open. Generally, limits on personal lines of credit range between $1,500 and $100,000 but higher amounts can be obtained.
What is a Personal Loan?
While, unlike a car loan or a mortgage, you don’t have to put up any collateral for a personal loan, you may have the option to do so. Some lenders offer secured personal loans that allow you to put up collateral if you want to obtain a lower interest rate. When you borrow money using a personal loan, you’ll get the cash up front to use as you see fit.
Personal loans are usually issued with a fixed term, typically one to seven years, and a fixed interest rate, which means you’ll have predictable fixed payments for the life of the loan. However, it is possible to find personal loans with variable interest rates if that’s what you prefer. Rates vary from as low as 2.49% to as high as 36%. Interest rates on personal loans are typically lower than those for personal lines of credit, because there is less uncertainty involved for the lender. You can borrow as little as $1,000 or as much as $100,000 or more in rare cases.
Choosing Between a Personal Line of Credit and a Personal Loan
Personal loans and personal lines of credit both have their merits. While you could use these types of debt interchangeably in many cases, there is usually a clear winner when you take a look at the details of your situation. Here’s how you can figure out which is right for you.
When You Should Choose a Personal Line of Credit
A personal line of credit is the best fit when you may need access to funds on a recurring, as-needed basis rather than as a lump sum. If you work on commission or are self-employed, you’re probably familiar with dealing with a variable income. A personal line of credit would allow you to borrow funds to help cover your expenses during lower-income months, while allowing you to repay the line of credit during higher-income months.
Similarly, a personal line of credit offers greater flexibility if you’re working on a project that doesn’t have a defined total cost, such as a home improvement project with an unknown final price tag. With a personal line of credit, you can borrow the money in stages as you require t. This can be preferable to paying interest on a lump sum from a personal loan, when you eventually may not need the full amount you borrowed.
When You Should Choose a Personal Loan
A personal loan is the right choice when you know how much money you’ll need, and there’s little or no chance of requiring additional funds in the future. For instance, when you’re seeking to consolidate your debts, you usually know precisely how much you owe before you borrow. This knowledge allows you to save money, since you don’t need the flexibility of a line of credit, and have no need to pay the higher interest rate that often comes with one.
Other uses of personal loans include paying for:
- Major car repairs.
- Home improvement projects with strict budgets.
- A wedding with a strict budget.
- Medical bills.
- An unexpected tax bill.
All of these uses typically require payment within a short period of time, so there is no need for the flexibility of multiple draws from a line of credit. Instead, you can get a lump sum that covers all of the costs with a single loan transaction.