Personal Line of Credit vs. Personal Loan: What Are the Key Differences?
Over the course of a lifetime, you probably will need to borrow money at least once. Whether it’s to buy a new car, send a kid to college or refurbish your home, you may find yourself a tad confused over what your best options are. A personal line of credit and a personal loan are often referred to interchangeably, but there are key differences you should know about before you decide which is right for you.
What Is a Personal Loan?
Last year, more than 114 million Americans took out personal loans of some kind. Put simply, a personal loan is a sum of money that you borrow from a bank, online lender or credit union that will be deposited in your bank account in a lump sum. You’ll agree to pay this loan back over a set number of years and will probably start paying interest right away. If you decide to pay back the loan early, you could be charged a prepayment penalty.
A personal loan could be a good fit if you know you need a set or known amount of money, such as $10,000 to build a home extension.
The two main types of such loans are secured and unsecured loans. A secured loan will be pegged to an asset such as your home, meaning that if you don’t pay what you owe, you could be at risk of losing your home.
What Is a Personal Line of Credit?
A personal line of credit works in a similar fashion to a credit card. You borrow money up to a maximum limit, withdrawing it as and when you need it. As with a credit card, you pay interest only on what you borrow — if you agree to a line of credit of $5,000 but only borrow $2,000, you’d only pay the interest on that $2,000.
The key difference between a credit card and personal line of credit is that with a line of credit, you start paying interest right away on what you borrow, while with a credit card, you will only pay interest when you don’t pay the whole balance from your monthly billing cycle. You also won’t earn cash back or air miles that are available with some credit cards. A personal line of credit may work well for someone with a fluctuating income such as a freelancer, who may need to draw out during drier work spells and can repay during busier periods.
Personal Line of Credit vs. Personal Loan
While a line of credit and a personal loan can help you borrow the sum of money you need, there are key differences between them.
What You Pay Back
The interest rate for a personal loan is most likely going to be fixed, somewhere between 5% and 36%, but with a line of credit, the interest rate may well be variable — somewhere between 8% and24%. Additionally, a personal loan will usually incur an origination fee of between 1% and 6%, while a personal line of credit normally involves an annual fee of between $25–$50.
How You Pay the Money Back
While personal loans usually have a set number of years for repayment (known as the term), personal lines of credit can have variable terms. This might seem like a positive if you want more time to repay what you borrow, but bear in mind that the interest will be building up. Your personal loan will also probably have a fixed monthly payment amount, while a personal line of credit will have a minimum monthly repayment.
How You Receive Your Funds
A personal loan will be delivered in a lump sum, but you can draw from your personal line of credit as and when you need it. To avoid paying more interest than is necessary, though, it’s always best to avoid borrowing more than you know you’ll need.
However you decide to borrow the funds you need, having a decent credit score is key to obtaining the best possible interest rates. SmartCredit makes it easy to take control of your future credit score, with gamified tools that help track and build your score with ease.