Are you contemplating a personal loan versus a personal line of credit?
Finding personal financing can be a real hassle, but the good news is that there is a range of products available to help you bridge the financial gap. Personal loans and personal lines of credit are two of the most popular, but there are some key differences between them you need to be aware of.
Depending on your situation, one could be a better choice than the other, but neither is perfect and it’s possible to end up in trouble with either product. This overview will explain personal loans and personal lines of credit and help give you an idea of the best use cases for each.
What is a Personal Loan?
Personal loans are financial products that provide funds for almost any need, including consolidating debt, taking a vacation, or renovating a home. Like auto loans and mortgages, personal loans are available from a variety of sources, including banks, credit unions, and online lenders. However, the best personal loan providers offer better rates, lower fees, and more favorable terms, so it’s important to shop around.
Lenders apply an interest rate and there may be fees over time, and the term generally depends on the length of the loan and the amount. Because many personal loans are unsecured, which means that there is no collateral like a car or house behind them, interest rates and other charges can be higher than for auto loans and mortgages. Some secured personal loans require the borrower to put up cash or other assets to ensure timely payback.
Many lenders do not ask about the purpose of the loan, but some have limitations. The application process is very similar to mortgages and other loans, with some lenders requiring more documentation and paperwork than others. Lenders generally require an application, proof of income, a credit check, and other steps. If you’re approved, the lender will present you with the terms and conditions of the loan, including the length and interest rate it will charge. You’re not on the hook to start repayment until and unless you accept those terms, so an approval is not a requirement to take a loan. If you do accept, the lender may offer a range of funding options, including direct deposit, a check, or other payment processes.
Personal Loans Features
Personal loans can be a great way to fund almost anything in your life. Most lenders offer a modern, quick application process, and the speed of today’s technology means that running a credit check takes just minutes. If you’re considering a personal loan, it’s a good idea to shop around and take some time to get a deep understanding of your current credit situation.
- Can be used for almost any purpose
- Must be repaid monthly like mortgages and auto loans
- Can be secured or unsecured
- Interest rates and terms depend on the borrower’s credit and the loan amount
What is a Personal Line of Credit?
Personal lines of credit are similar to personal loans in a few ways, but borrowers don’t repay them like traditional loans. Instead, they work more like credit cards, allowing withdrawals until the borrower has reached their credit limit. Lenders generally don’t limit the use of funds taken under a personal line of credit, and the borrower has a minimum payment amount, like with credit cards.
Personal lines of credit also offer the ability to “re-borrow” funds as the borrower makes payments. Many can be repaid and used again as long as the borrower has maintained their end of the deal. The credit line has a time limit, and the borrower must make sure all payments have been satisfied before it expires.
Credit lines are generally unsecured and can come with steeper fees and higher interest rates than personal loans. There may also be cash advance fees for certain types of withdrawals, and many lenders charge an annual maintenance fee to keep the line open over time.
Personal Lines of Credit Features
Depending on the borrower’s situation, a personal line of credit can be a better financial tool than a personal loan. That said, they can come with more scrutiny around the borrower, as they are considered revolving credit and are usually unsecured.
- Functions similar to a credit card
- The borrower can withdraw and repay multiple times within the lending terms
- May have higher interest rates, more fees, and more buyer scrutiny than loans
- Can be used for almost any purpose
Personal Loan Pros and Cons
It’s easy to get excited about receiving a personal loan, especially if you have something exciting planned for the funds. Even so, they come with a range of pros and cons that you should consider before applying. If you’re unsure about any of the benefits or drawbacks, it’s best to check with a financial professional to get all of the facts before making a decision.
Pros
- Personal loans can be funded as fast as one business day
- Interest rates can be lower than with personal lines of credit
- The borrower receives a lump-sum payment
- Personal loans can be used for almost anything
Cons
- Personal loans can have strict credit requirements
- Fees and other charges add up over time
- Taking a personal loan increases your debt load
- Payments may be higher than with a credit card
Personal Line of Credit Pros and Cons
Personal lines of credit can provide funding for a range of purposes, and the ability to repay and borrow again can be a significant benefit for borrowers. That said, they come with risks, and there are some downsides to lines of credit compared to personal loans. Carefully consider the drawbacks before choosing between a credit line or loan.
Pros
- You only pay interest on the money you borrow instead of a larger loan amount
- Personal lines of credit can be repaid and used again
- Funds can be used for almost anything
Cons
- Personal lines of credit can have higher interest rates than loans
- There are often more fees with personal lines of credit
- Lenders require strong credit histories for borrowers
Things to Know About Personal Loans
Personal loans are powerful financial tools that can make a world of difference for borrowers seeking funds. Because they can be used for almost any purpose, personal loans don’t have to be tied to a purchase, making them ideal to pay for services and other things traditional loans can’t touch.
Personal Loan Uses
Many people look to personal loans to pay for home renovations because receiving a lump sum upfront makes it easier to pay a contractor and purchase materials. They also untether the renovations from the home’s mortgage, so there is no need for a complicated home equity loan or other process. Some use personal loans for debt consolidation, taking higher-interest debt from credit cards and combining it under a simpler payment plan and interest rate.
That said, some people choose to use personal loans to make purchases for items like power sports equipment, boats, recreational vehicles, and more. Depending on the lender, some traditional loans for those items can come with high interest rates and fees, making a personal loan a more appealing option.
Things to Know About Personal Lines of Credit
Personal lines of credit are an excellent way to get financing if you don’t need all of the money upfront, and they can provide you with a flexible funding format that loans can’t. Credit lines can be used for almost any purpose, so you won’t have to worry about what you buy or pay for with the funds, and they can be repaid and used again and again within the term of the agreement.
Personal Line of Credit Uses
Like personal loans, personal lines of credit can be used for almost any purpose. Many borrowers choose to use their credit lines to pay for unexpected expenses, such as medical costs, while others use their credit to fund a home renovation or other project. Personal lines of credit should not be used as income replacement or for frivolous purchases, however, because their interest rates and fees can make them an expensive alternative to traditional credit.
Who Are Personal Loans Best For?
Personal loans are best for people comfortable with a traditional lending process and regular monthly payments. Their upfront lump-sum payment makes them ideal for funding large projects like home improvements, and the straightforward repayment schedule will be familiar to anyone who has ever purchased a home or car on credit. They are also great for people without significant collateral, as many personal loans are unsecured.
That said, personal loans can be expensive, and many require high personal credit scores to qualify. They can also significantly impact your credit score, so if you’re unsure about your ability to repay the loan on time, it’s a good idea to steer clear or find another solution.
Who Are Personal Lines of Credit Best For?
Personal lines of credit provide a more flexible funding platform, allowing the borrower to choose when to withdraw money and how much to take. They work well for people who are unsure of their funding needs or when they will need the money and can be repaid and borrowed again for the term of the credit line. Like personal loans, they can be used for almost any purchase or reason.
Sharon Hayut of Magus Financial said, “Understanding the difference between a personal loan and a line of credit can help with deciding which one is best suited for your situation. Personal loans are installment loans and are generally more suited for one-time expenses or debt consolidation. They provide for a fixed rate and a fixed term allowing for better planning on the cash flow and budgeting of your expenses. Generally, they also provide for a more attractive interest rate. Lines of credit are flexible funding sources that allow for flexibility with the amount withdrawn and timing. We generally recommend having a line of credit established for emergencies…”
Personal Loan Vs. Personal Line of Credit: Which Is Better?
There are many similarities between personal loans and lines of credit, making it difficult to determine a “winner.” Since they can both be used for almost any funding need, the choice between them comes down to whether you need a hefty upfront payment or smaller amounts over time. The interest rates can be similar, and fees depend on the lender, so it’s essential to research your options before making a decision.
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