When it comes to consumer lending products, there are many options available online with a variety of use cases. For those in need of access to cash that isn’t tied to one specific use (e.g., an auto loan or student loan), there are two main avenues to take that, while somewhat similar, differ in several key aspects. They are a personal line of credit and a personal loan.
To understand which of the two makes more sense for a given consumer, it’s important to distinguish a line of credit from a personal loan, as far as how it’s obtained, how funds are accessed, and how the borrowed funds are ultimately paid back to the lender.
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Applying for a personal loan or a line of a credit is actually a fairly similar process. While every lender is different, applicants are usually assessed based on their debt-to-income ratio and creditworthiness. This will determine if they are approved for the product, the amount they can borrow, and the interest rate they are eligible for. After that, however, is where a line of credit and personal loan start to differ heavily.
With a personal loan, a borrower will receive a lump sum of money typically deposited into their checking account. The amount can range from as low as $1,000 to as high as $250,000, depending on how much the borrower needs and how much the lender will approve. A borrower may need the money to pay for a large expense, like booking a wedding venue, or to (link: /learn/articles/how-a-personal-loan-can-ease-credit-card-debt text: pay off existing high-interest debt), like that of a credit card.
With a line of credit, on the other hand, a borrower does not receive a one-time, lump sum payment. Instead, they are given access to an account they could draw (i.e., borrow) from as many times as they want. The account has a limit, however, similar to the spending limit on a credit card. A borrower can redraw from the account as long as there are funds available, even if they owe money from a previous draw.
As with any type of lending product, the money borrowed must be paid back to the lender according to the contractual terms of the loan agreement. Failure to do so results in a delinquent loan, with potential penalty charges, and ultimately a defaulted loan after a certain time period.
When a borrower takes out a personal loan, it’s typically an unsecured loan with a fixed APR, which accounts for the interest rate and applicable loan fees. Repaying the debt involves making monthly installments of the same amount over the life of the loan (i.e., loan term), which can range from 24 months to 84 months. When agreeing to loan terms, choosing a shorter time frame will result in larger monthly payments (with less total interest paid) while a longer term will stretch out the repayment, resulting in smaller monthly installment, but more paid in total interest.
With a line of credit, a borrower does not make fixed monthly payments, but instead receives a billing statement, similar to a credit card, with a mandatory minimum payment requirement to avoid penalties. The total balance every billing cycle accounts for the principal amount owed (i.e., whatever was drawn and not repaid) plus interest charges. By paying the minimum amount, however, a borrower will incur additional interest charges on any unpaid balance from one cycle to the next.
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Which Makes More Sense?
Deciding between a personal loan and a personal line of credit can come down to several factors, based on both the borrower in question and what they need funds for. Typically, personal loans offer lower interest rates as the lender takes on less risk. As a result, for someone looking to refinance and/or consolidate high-interest debt, a personal loan likely makes more sense, due to the lower rates and fixed repayment schedule. Personal loans are also ideal for people in need of a lump sum for a big purchase.
A line of credit, on the other hand, may be better suited for someone who needs access to funds on a repeated and/or as-needed basis, whether it be for an emergency or due to a gap in income. A line of credit is also more flexible as far as monthly budgeting, since only a minimum payment is required, but can lead to more interest charges.
As illustrated above, a personal loan and line of credit have several differences that make them unique forms of borrowing money. While a personal loan may make more sense for a one-time payment, a line of credit can act as an emergency fund for repetitive use and quick access.
No matter which option a consumer chooses, it’s important to pick a product that matches your financial situation, to avoid mounting interest charges and other fees. With Fiona, users can compare offers with flexible rates and terms, to make sure they are choosing the option that suits their needs best.
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