Line of credits and personal loans are similar, but have differences and are used for different purposes. A line of credit allows you to draw funds up to an agreed-upon limit, and only requires that you pay interest on the funds you use. A personal loan is a lump sum given to you by the lender, which requires fixed monthly repayments until you pay off the balance. Understanding the pros and cons of each of these financial tools can help you determine which is best for your unique situation.
A line of credit is an amount you can borrow from a lender up to a certain limit. This loan offers flexibility and convenience, allowing you to borrow what you need and repay over time.
A personal loan is usually unsecured and may have a higher interest rate than a secured loan. You can use personal loans to make large purchases or consolidate debt.
Consider the repayment terms, interest rates, fees, and any additional features (like flexible repayment options) to see which option suits you better.
What Is a Line of Credit?
A line of credit is a type of loan that allows you to borrow only the money you need and when you need it, unlike a traditional loan, which comes in a lump sum. For instance, a credit card is a line of credit, as is a home equity line of credit (HELOC). You can apply for a line of credit to manage cash flow, cover unexpected expenses, and consolidate debt.
You can apply for a line of credit through most banks or online lenders. You will be expected to pay back what you owe according to the loan agreement, usually a minimum monthly payment set in the contract. If you don’t pay on time, you may face late penalties and might find yourself in default.
Features of a Line of Credit
When considering a line of credit, it’s vital to understand the general qualifications, interest rates and repayment terms.
Generally, lenders require applicants to have proof of steady income, up-to-date bank statements, a good credit score and sometimes collateral to qualify for a line of credit.
This will vary depending on your bank, the type of credit and your financial circumstances. The average interest rate for credit cards is 19.07%.
You will generally pay a line of credit monthly, with a minimum amount set in the agreement with the lender. If you pay off the principal in full each month you may avoid incurring interest.
Pros and Cons of a Line of Credit
Before you speak to your lender and apply for a line of credit, it's best to consider the pros and cons.
Pros and Cons
- The interest rate may be lower than other types of loans, depending on your financial circumstances.
- Payments are flexible, allowing you to pay for a big-ticket purchase over time.
- You can access funds quickly without waiting for approval, depending on your line of credit’s limit.
- Interest rates on lines of credit often adjust according to market conditions.
- Continued access to funds can make it easy to continue accessing and maxing out your line of credit.
- Closing a line of credit can affect your debt-to-income ratio, which might prevent you from getting other loans or lines of credit down the road.
What Is a Personal Loan?
A personal loan can help you access funds you can use for various reasons. Banks, online lenders and credit unions are sources for personal loans..
Lenders may consider your financial history, desired loan amount and other factors when you apply for a personal loan. If you qualify, the lender will offer a fixed term length and interest rate, which you can accept or dismiss. If you agree, you will receive your funds in a lump sum, which must be repaid in monthly installments according to your agreement.
If you fail to make your payments, your lender may apply penalties and additional fees or even pursue legal action.
Features of a Personal Loan
Before applying for a personal loan, it helps to consider the features that come with your loan agreement.
To qualify for a personal loan, most lenders require borrowers to have a good credit rating and decent debt-to-income (DTI) ratio that shows your lender that they can abide by payment terms. Some lenders may require collateral or ask to see income tax documents annually for verification purposes.
Personal loan interest rates can vary depending on several factors such as the type of loan, the amount borrowed and your credit score. The average rate for a personal loan is 11.23%.
Most lenders require monthly repayment, including interest and principal payments. The repayment term can range from six months to several years, starting immediately after the loan is disbursed.
Pros and Cons of a Personal Loan
Despite the ease and convenience of personal loans, you should consider the various pros and cons of a personal loan before applying.
Pros and Cons
- Comes with low interest rates if you have good credit.
- Grants you access to a lump sum of cash you can repay over time.
- Helps you build credit if you make your payments on time.
- May have a high interest rate if you don’t have good credit.
- May involve fees for origination, application or late payments.
- May require collateral, like a house, car or another high-value asset.
Which Is Better: Line of Credit or Personal Loan?
The best option for you when you’re weighing a line of credit vs. a personal loan will depend on your financial needs and circumstances.
Here are some points to remember to help you choose the right loan for your needs:
- Creditworthiness: Do you qualify for the credit score specified by the lender?
- Job Stability: Is your income consistent enough to meet the payment terms?
- Purpose of Taking Out a Loan: Are you making a purchase you truly need? Consider whether you should borrow funds.
- Penalties: Are you prepared to shoulder penalty fees in case of late payments?
Answering these questions can help you find the right loan.
FAQs About Lines of Credit and Personal Loans
- Federal Reserve. "Consumer Credit - G.19." Accessed January 20, 2023.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
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