The Difference Between a Personal Loan and Line of Credit
Personal loans and lines of credit are the two most common options for borrowers looking for unsecured funds. There might be times when an individual requires money to pay taxes, upgrade home, consolidate debt, or finance an unexpected medical emergency.
Depending on the situation, a personal loan or a line of credit helps people accomplish their goals. While both the options give access to the required funds, they work differently. Therefore, understanding their differences will go a long way to choosing the best option. Discussed below are a few points of difference between a personal loan and a line of credit.
Few Points Of Difference Between A Personal Loan And A Line Of Credit
Interest Rates
Personal loans usually come with fixed interest rates. Borrowers with a high credit score often get the lowest personal loan rates. However, lenders determine several factors while deciding the rates, including the market rate and the borrower’s age, employment, income, loan amount, loan term, and repayment capacity.
On the other hand, a line of credit comes with a higher interest rate with more flexibility. Yet, unlike a personal loan, the interest rate does not kick in as soon as the lender approves the loan. Instead, the borrower starts paying the interest only when they access a part of the available funds.
Amount to Borrow
The borrowed amount depends on a number of factors, including the borrower’s income, credit score, funds requirement, and the lender’s maximum amount.
In the case of a personal loan, the borrower receives the total amount in a lump sum. In a line of credit, an individual borrows up to their account limit. If they remain in good standing, they may pay their borrowed amount to reduce their balance and borrow back again up to their account limit.
Application Process
Both personal loans and lines of credit have similar application processes. The lender reviews the borrower’s credit score, income, and assets to determine their creditworthiness and repayment capacity. The better the credit score is, the better are the odds of getting a personal loan or line of credit.
However, one big difference is that the borrower knows the loan amount to borrow upfront in a personal loan. In a line of credit, the lender makes a maximum amount available to the borrower, and the borrower uses a part of it as and when needed.
Repayment Method
Personal loans have a fixed repayment amount that borrowers pay every month. The personal loan EMI consists of the principal amount and the interest cost, which the borrower pays each month throughout the loan term.
Since the borrowers calculate their EMIs and choose a repayment term suitable to their monthly budget, they can plan their expenses to fit in their EMIs.
However, in a line of credit, the monthly payment may differ every month. This happens because the repayment amount depends on the amount borrowed and the current interest rate.
Additional Fees and Charges
Personal loan lenders charge an origination fee, processing fee, pre-payment fee, and other charges. However, charges applicable to the lines of credit are of a different type.
They include an annual fee for the draw period, a late payment fee, and other penalties if insufficient funds are in the account. Additional fees may also apply in the case of a frozen or closed account.
Term Length
Personal loans have flexible repayment terms that the borrower chooses with a personal loan EMI amount suitable to their budget.
However, a line of credit has two different terms: the repayment period and the draw period. The borrower accesses the credit up to their maximum limit during the draw period and repays the drawn amount during the repayment period.
Choosing Between a Personal Loan and a Line of Credit
Although personal loans and lines of credit have many similarities, they have different ways to help people achieve their financial goals. The final choice between the two depends on the individual’s needs.
If the borrower needs to pay for an expense in a single payment, they should opt for a personal loan. However, in the case of a recurring expense, a line of credit would be the better option.
A personal loan is suitable for big purchases and debt consolidation, while a line of credit helps break major expenses into smaller, affordable pieces.
If a personal loan is too small to cover the costs, the borrower may end up borrowing again. Therefore, a line of credit may make funds available to an individual as and when they need them.
The Last Words
The bottom line is that an individual can simplify life and save money by choosing the right financial product suitable to their situation. Do some research while choosing the final product and the lender and feel confident in any situation.
