Credit

Personal Line of Credit vs. Personal Loans

You can borrow money through a personal line of credit or a personal loan. You won’t need collateral (aka an asset that secures a loan) for either loan. And both are repaid over a set period of time. Either one is a great option for making large purchases or financing big projects. And you can generally get the money you need quickly.

But there are a few key differences that, depending on your financial situation, can either work to your advantage or disadvantage. To help you decide which option is right for you, we’re going to take a look at how personal lines of credit and personal loans operate.

What Is a Personal Line of Credit and How Does It Work?

A personal line of credit, which is usually an unsecured loan, functions a lot like a credit card. Personal lines of credit and credit cards are both types of revolving credit – but they aren’t the same thing.

With a personal line of credit, borrowers receive a revolving line of credit from a lender, like a bank or credit union. And just like a credit card company, your lender sets a credit or borrowing limit. But the similarities don’t end there. You can tap into your line of credit for any purpose and continue to use it as long as you make your minimum monthly payments.

Where credit cards and personal lines of credit diverge is the draw period. There is no draw period with a credit card. But, with a personal line of credit, your lender sets the length of time you can withdraw money (aka your draw period). At the end of the draw period, the loan switches over to the repayment period.

Draw periods vary by lender and typically range from 5 – 10 years. During the draw period, you only pay interest on what you borrow.

During the repayment period, you can no longer withdraw money. You continue making your monthly payments – which will now be made up of the loan’s balance and interest – until you pay off the loan.

How to qualify for a personal line of credit

To qualify, lenders will have requirements you’ll need to meet, including:

  • Credit score: A score of 670 or higher will get you more favorable terms. The higher your score, the better your terms. If you have a low credit score, you may find it easier to qualify for a personal loan than a personal line of credit.
  • Debt-to-income (DTI) ratio: A DTI of 36% or lower is ideal, but some lenders will work with you even if you have a DTI of 50%.
  • Personal finances: You’ll need proof of income and employment so a lender knows you can afford to pay back the loan. The lender will also review your credit report to examine your record of paying bills. If your credit score is high, it’s likely because you have a strong record of on-time payments.

The application process

You can apply for a personal line of credit like you would for any other loan. Shop around and compare lenders to find the best interest rates and terms for you. You can either apply for the loan online or in person at a lender’s office.

When you apply, the lender will look at your credit score, credit history, income and assets to decide whether to extend a line of credit to you. You may be approved in as little as 24 hours. You will likely receive a debit card or checkbook to access the funds. But, in some cases, you may be able to transfer the money from your line of credit to your checking account.

Interest rates

One great thing about a personal line of credit is that you’re only charged interest on the amount you withdraw. The downside is that personal lines of credit usually have higher interest rates than personal loans (we’ll get to those later). The rates are usually variable rates, which means the rates can change (increase or decrease), and your monthly payments can change with it.

Borrowing limits

Your credit limit will depend on your credit score and income. The higher your credit score and the more income you earn, the better your chances are of a lender offering a high credit limit. Lenders may extend a line of credit up to $100,000 or even $500,000.

The good news is that since it’s revolving credit, as long as you continue to make your payments, you can continue borrowing money up to your credit limit during your draw period.

Flexible

Personal lines of credit are flexible. You can use a line of credit for any purpose and tap into the funds as necessary.

Pay interest on purchases only

You only pay Interest on what you withdraw.

Revolving credit

When you pay back what you withdraw or make the minimum monthly payment, you can continue to borrow.

Quick turnaround

You may be able to get the loan in as little as 24 hours.

Estimate what you need

If you need ongoing access to cash or aren’t sure how much a project will cost, a personal line of credit gives you access to money when you don’t know how much of it you’ll need, putting less pressure on you to use the total amount you’re approved for.

Higher interest rates

Personal lines of credit typically have higher interest rates than personal loans.

Fees

You might have to pay fees if you don’t make your minimum monthly payment or make a late payment. You may also be charged annual fees and overdraft fees.

Higher credit qualification

You may need a higher credit score to qualify for a personal line of credit than a personal loan.

Restrictive draw period

The draw period typically lasts for 5 – 10 years.

What Is a Personal Loan and How Does It Work?

Personal loans are typically unsecured loans that work like installment credit. Because they’re unsecured, they’re a lot more flexible than secured loans. You can get a personal loan from a bank or other private lender.

You receive a lump-sum payment from your lender and agree to repay the loan with interest over a set period of time. The trick with personal loans is to know how much money you want to borrow when you apply because interest is charged on the entire loan amount.

Doing some calculations before applying for a personal loan can save you from overestimating or underestimating how much money you’ll need to borrow, which might save you from paying more in interest than you need to.

How to qualify for a personal loan

To qualify, lenders will have requirements you’ll need to meet, including:

  • Credit score: A score in the mid-600s will get you favorable terms. If your score is in the 700+ range, you’ll likely get much better terms. Some loans are geared toward borrowers with low credit scores, but their interest rates are higher.
  • Debt-to-income (DTI) ratio: A DTI of 36% or lower is ideal, but some lenders will work with you even if you have a DTI of 50%.
  • Personal finances: You’ll need proof of income and employment so a lender knows you can afford to pay back the loan. The lender will also review your credit report to examine your record of paying bills. If your credit score is high, it’s likely because you have a strong record of on-time payments.

The application process

Shop around to find the best interest rates and terms for your situation then apply online or in person.

When you apply, your lender will look at your credit score, credit history, income and assets to decide whether they want to give you a loan. You may be approved in as little as 24 hours, but in most cases, approval takes around 7 – 10 days.

Interest rates

Because personal loans are unsecured, their interest rates are usually higher than interest rates for secured loans. However, personal loans typically have lower interest rates than personal lines of credit.

With a personal loan, there is a fixed repayment period with fixed monthly payments. Generally, the loan’s fixed interest rates range from 5% – 36%. That interest starts accruing on the total loan amount from day one. It’s different from how interest accrues on personal lines of credit, where you pay interest only on your purchases.

Borrowing limits

Your borrowing limit will depend on your creditworthiness, debt and income. The better you look financially, the better your chances of getting approved for the loan. Most personal loan limits are around $50,000, but some can be as high as $100,000. And the repayment period can range from 2 – 7 years.

Easier to manage

Borrowers may find fixed payments easier to budget for and manage.

Lower interest rate

Personal loans typically have lower interest rates than personal lines of credit.

Flexible

Unsecured loans offer more purchasing flexibility than secured loans.

Quick turnaround

You can usually get the money quickly.

Pay interest on the entire amount

Even if you don’t use the funds right away, interest accrues from day one on the entire loan amount.

Fees

There can be many fees: an origination fee, an application fee, a late payment fee and there may even be a prepayment fee if you pay your loan off early.

Fixed loan amount

If you wind up needing more money after you take out your loan, you’ll have to go through the application process again.

Have to repay the entire amount

Even if you borrowed more money than you used, you still have to repay the entire loan, including interest.

Biggest Similarities and Differences Between Personal Lines of Credit and Personal Loans

Personal lines of credit and personal loans share many similarities, but they also have some key differences. Let’s take a closer look.

Similarities

One of the main similarities personal lines of credit and personal loans share is their flexibility. The loans can be used for any purpose. Here are a few more similarities to keep in mind:

  • Both come with interest payments
  • Both have very similar qualification requirements
  • Both require a hard credit check
  • Both are good for making larger purchases (more on this in a bit)
  • Both are unsecured

Differences

The main differences between a line of credit and a personal loan are the loans’ terms and how you pay them back. Here are a few more to keep in mind.

Personal Line of Credit Personal Loan
Has a variable interest rate that’s usually higher than personal loans Has a fixed interest rate that’s usually lower than personal lines of credit
Open-ended credit, up to credit limit Receive loan in a one-time lump-sum
Interest only applies to withdrawals Interest is charged over the loan’s term from day one
Revolving credit Installment credit

Which Is Right for You?

There are many factors to consider when it comes to making decisions about debt. And whether a personal line of credit or personal loan is the better option will be based on your financial situation. Let’s sum up some key reasons why either option may, or may not, be right for you.

Personal line of credit

A personal line of credit is good for ongoing or unpredictable larger expenses, like a home project or emergency funds. Or it may help you pay for expenses when there are gaps in your income.

During your draw period, you can continuously borrow money up to your credit limit, and you’re only charged interest on what you withdraw. A line of credit may be a better option than a personal loan if you have unpredictable income since you only repay it when/if you use it. Because the interest rate is usually a variable interest rate, your monthly payments may increase or decrease.

You’ll likely need a higher credit score to qualify for a line of credit than a loan. If you have a low credit score, a bad credit personal loan may be a better option.

Personal loan

A personal loan is good for a large, one-time expense. You know how much money you need, and you need it all upfront. Personal loans are typically used to help pay off credit card debt (FYI: credit cards typically have higher interest rates than personal loans), pay for weddings or medical debt.

Because you have a fixed interest rate and fixed monthly payments, repayment is more predictable. Personal loans are generally better suited for borrowers with stable incomes.

Know Your Goals To Pick the Best Option for You

When you know why you want to borrow money, what your current financial situation is and how you plan to repay the money you borrow, choosing between personal lines of credit and personal loans gets a lot easier!

Don’t rush into a decision. Take the time to weigh all your options so you can enjoy the fruits of your decision.

What's your reaction?

Excited
0
Happy
0
In Love
0
Not Sure
0
Silly
0

You may also like

More in:Credit

Leave a reply

Your email address will not be published. Required fields are marked *