Are you trying to pick the best between a personal loan vs line of credit? If YES, here is a detailed comparison between personal loans and line of credit.
When it comes to credit financing in the world today, there are so many options that it’s easy to get confused about the right one to choose. However, it’s very important to always choose the best option for your needs and with interest rates that you can afford.
In this article, you’ll learn the difference between personal loan and personal line of credit. You’ll also learn which one is the best option to choose in different circumstances.
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What is a Personal Loan?
A personal loan is a lump sum amount that you get from your bank or financial institution which you would be expected to pay back at a future date with interest.
Personal loans can be used for financing emergency expenses, for purchasing a car, renovating your home, or for debt consolidation purposes. The interest rates for a personal loan may be fixed or variable and repayment options differ according to the loan amount, purpose, and other factors.
A personal loan may also be secured or unsecured. To obtain a secured personal loan, you’ll have to put down an asset as collateral security so that in the event you default on your loan repayments or you are unable to repay the loan, the collateral security will be used by the financial institution to offset the loan amount.
Unsecured personal loans on the other hand are for people who do not have any assets that can be used as collateral security. Unsecured loans are high risk loans and since there are no assets that can be sold off by the financial institution in order to recover its funds should you be unable to repay the loan, the bank will usually charge a very huge amount as interest rate.
What is a Personal Line of Credit?
A personal line of credit differs from a personal loan in a number of ways although both have a few similarities.
A personal line of credit is a reusable loan offered to an individual which can be accessed whenever they want. So let’s say you want a personal line of credit; you have to submit all the required paperwork, the bank will go through it and decide if you qualify for a line of credit or otherwise.
If you qualify, the bank will approve a specific sum as line of credit. If the bank approves $10,000 personal line of credit, you can decide to withdraw the entire sum, or withdraw some of it (say $2,000).
Now, here’s the catch- if you ever need extra funds in the future, you don’t need to apply for another loan as long as the line of credit is still valid; you can just withdraw from your existing line of credit, and then repay everything at the end of the loan term.
A line of credit works just like a credit card and you’ll be charged interest rates for amounts withdrawn and utilized from the line of credit and not for the entire sum approved. So if you only withdrew $2,000 out of the $10,000 approved, you’ll only need to pay interests on the $2,000 you withdrew.
Just like personal loans, there are two different types of personal line of credit- unsecured personal line of credit that can be obtained without collateral security but at a higher interest rate, and secured personal line of credit that has to be obtained with collateral security.
Personal Loan vs Line of Credit Loan: Which is the Best?
There are a few considerations to make when trying to determine the best option for you between a personal loan and a personal line of credit.
A personal loan involves receiving a lump sum payment upon approval, and then paying fixed monthly installments every month while a personal line of credit is more flexible – it is up to you to determine how much you can afford to pay back monthly, and then limit your withdrawal to that amount.
When to Apply for a Personal Loan
It’s best to apply for a personal loan when you need lump sum (huge amounts) to finance one-time expenses.
For instance, if you need to repair your home and need to make payments at once, you can apply for a personal loan.
Personal loans are also great for debt consolidation purposes. You can consolidate several high-interest credit cards into a single personal loan so as to reduce your interest rates. Personal loans can also be used for emergency expenses that require huge funds.
When to Apply for Personal Line of Credit
Personal line of credit on the other hand is best for when you need access to constant cash flow but don’t necessarily need to make immediate expenses. For instance, if you are a self-employed individual with irregular income, you can apply for a personal line of credit so that you can have access to cash that you can use to finance your monthly expenses, and then repay when you receive cash inflow.