Financial products such as a personal loan or a personal line of credit can help you get on top of your budget, but they both work in very different ways. Knowing which one is best for your situation comes down to understanding how they function as products.
What’s The Difference?
A personal line of credit is very similar to a credit card. There is a predetermined limited amount of money you can borrow from as and when needed over a set term; you can pay down the balance at any point, and then that credit is available to you again. Interest accumulates on the outstanding balance, so if you pay off your balance in full each month, you will pay no interest. If you make only the minimum payments each month, interest, and the amount you owe, will accumulate very quickly
A personal loan offers you a fixed amount of money in a lump sum that you repay at a fixed amount over a fixed period. No matter how much of your loan you use, you still have to pay back the entire amount plus interest, but you’ll know exactly how much you’ll be paying each month from the get go.
The predictable and fixed nature of repayments on a personal loan makes it easier to budget for each month. In contrast, a personal line of credit offers greater flexibility when borrowing that is governed by how well you manage its liquidity.
What Are They Used For?
A personal loan or line of credit can be used for a multitude of things; the main factor to consider when choosing which option is best is to look at whether the initial need for the credit is immediate or ongoing.
Generally speaking, a personal loan is best for covering large purchases. Many people use personal loans to consolidate previous debts, take care of emergency medical expenses, pay for a significant life event such as a wedding, or cover fixed-price home repairs.
Personal Line of Credit
A personal line of credit is often used to cover flexible expenses. For example, helping to mitigate fluctuations in income month to month when self-employed or financing ongoing projects such as a home renovation where the overall costs may not be apparent at the start.
Qualifications and Approval
Each financial institution will have slight variations in what they need to determine eligibility for a loan, but as a general rule, lenders will take into consideration the following:
- Your financial and credit history (including if you have ever filed for bankruptcy),
- Current income (and sometimes expenses, such as bills, mortgages, etc),
- The reason for the personal loan
- The value of collateral (for secured loans)
- Your state of residence.
Interest Rates and Terms
The interest rates and terms you get offered on both a personal loan and personal line of credit will vary depending on individual circumstances.
Usually, your credit score and current income and expenses will be the main factors in deciding how much you can borrow at specific rates and terms. A better credit score will generally afford you a lower interest rate. Some lenders may also give you the option to take the credit as secured which may further improve the rates and terms.
Making The Choice
Personal finance is always unique to your current situation. When weighing up whether to opt for a loan or line of credit remember to consider its initial purpose and also the factors of interest and repayment terms.