A personal loan or a line of credit? That is the question. You make a decent living, and you can usually cover your financial obligations with your regular income. But you’re facing a major expense that’s beyond your budget, and you’ve decided to take a personal loan. Or perhaps you’ll opt for a line of credit. You actually cannot decide between the two.
Both personal loans and lines of credit provide extra cash. Each is considered to be a form of credit and personal loans and lines of credit share many similarities, at least on the surface. In reality, personal loans and lines of credit operate quite differently from one another. Choosing between the two is largely a personal decision, although how you intend to use the money may also have a bearing.
In this article
What Is A Personal Loan
When most people use the term “loan” what they’re referring to is a personal loan. Personal loans are issued for a set amount of money with a specified interest rate and repayment period. Personal loans represent a form of installment credit because repayment of the loan is divided into specific amounts, called installments that are paid over time. Once the final payment has been posted, the loan is completely paid off, and the borrower’s balance returns to zero.
Pros And Cons Of A Personal Loan
Personal loans are ideal for one-time expenses such as home improvements or emergency car repairs. Personal loans can also be used to consolidate credit card bills into a single payment. Except for high-interest payday loans, personal loans often carry a lower interest rate than credit cards. Consolidating credit card payments can result in significant savings over the long run. Personal loans also carry fixed interest rates and monthly payments which help with budgeting. As long as borrowers maintain regular payments, the balance that is owed for personal loans gradually decreases until the amount reaches zero.
The main downside of personal loans is that once borrowers receive the money, that’s all that is available. It can be difficult to obtain another loan while the first loan is still in repayment. Once the first loan is paid off, borrowers have to apply all over again for a second loan. A second disadvantage of personal loans is that interest is charged from the day that the loan is dispensed, even if borrowers don’t use the money right away. Interest continues to be charged for the entire life of the loan, which often endures long after the money is long gone, which can create quite a drain on the budget.
Lines Of Credit
Lines of credit operate more like credit cards than actual loans. Like credit cards, lines of credit represent a form of revolving credit. Home equity loans are often issued as home equity lines of credit (HELOC).With lines of credit, lenders make specific amounts of money available to borrowers. Borrowers are free to withdraw the entire line of credit at once or make several smaller withdrawals up to the limit of the line of credit.
No payments are due on lines of credit until borrowers begin to withdraw funds. Repayment amounts vary according to how much is withdrawn from the line of credit during a specific payment period. As with personal loans, payments are applied to both principal and interest, and the line of credit is replenished by the amount of the payment applied to the principal.
Pros And Cons Of Lines Of Credit
The fact that the repayment plan does not begin until borrowers make withdrawals represents a significant advantage for lines of credit. The flexibility of the withdrawal and repayment process is another advantage for lines of credit.This flexibility makes lines of credit ideal for ongoing expenses, which is one reason why so many business owners prefer lines of credit to conventional business loans.
Individuals also find lines of credit can come in handy to cover long-term projects like remodeling and physical therapy for severe injuries. Borrowers can maintain a cycle of borrowing and repayment until the entire project is complete. The revolving nature of lines of credit means that funds are more likely to be available when they’re needed.
However, the revolving nature of lines of credit can also be a disadvantage. It’s very easy to fall into an endless trap of borrowing and making only partial repayments. Lines of credit also often have interest rates and monthly payments that vary depending on market conditions and how much has been borrowed. When the life of a line of credit has expired, borrowers must pay off the entire balance, either in a single payment or installments, just as with a personal loan. But if the line of credit expires when the balance is high, the repayment amount can be quite significant.
A Personal Loan Vs Lines Of Credit: Which Should You Choose?
Given the choice between a personal loan and a line of credit, which should borrowers elect? It depends on their circumstances and preferences. In general, personal loans are well-suited for one-time borrowing needs, while lines of credit are a good choice for borrowers who need funds on an ongoing basis.