Lines of credit may seem very similar to personal loans. Certainly, they both serve the general purpose of providing money for whatever purpose you choose. Yet, there are definitely differences you should understand.
Lines of Credit
Personal lines of credit function more like credit cards than loans. You’re approved for a set limit and can borrow repeatedly, providing you repay what you owe.
One major difference between a loan vs line of credit is that you aren’t issued a lump sum of money. Instead, you basically charge against your credit limit and then pay interest on the amount of credit you use. You do need to pay off the principal owed, but you usually have a long time to do so. In the meantime, you pay interest only.
How much interest you could pay is also a difference between a line of credit and loan. A line of credit has a variable rate, while a loan has a fixed interest rate. Consequently, when you use lines of credit you can’t calculate your required interest payments. The prime rate fluctuates and your payments go up and down with any changes.
Like any other financial products, lines of credit may suit certain situations more than others. They also come in many forms that may or may not apply to you.
Finally, lines of credit have advantages and disadvantages you should know about before you decide whether you want to use one.
Common Uses of Lines of Credit
- Ongoing home improvement projects
- Supplementing your cash flow if you earn an irregular income
- Making a large purchase
- Handling an emergency
- Don’t know the exact amount you need to borrow yet
Types of Lines of Credit
Most lines of credit are personal. In other words, they’re based on your finances and your credit. You may be able to obtain one from your financial institution or a private lender.
However, there are two other lines of credit that may apply to you. They are a business line of credit against your company or a line of credit against your home.
Business Line of Credit
A business line of credit can provide your company with access to working capital. The major advantage of a line of credit vs a loan is you have constant access to money instead of needing to apply for a loan each time.
Business lines of credit may be secured by an asset or unsecured with approval resting on your company’s credit worthiness.
HELOC (Home Equity Line of Credit)
These lines of credit are secured by the equity in your home. Basically, they act as a second mortgage. If you do not meet the obligations of your line of credit, your creditor may seize your home to recoup the money you owe.
Advantages of Lines of Credit
- Ongoing access to funds
- Can make interest-only payments for long period
- Unrestricted usage of funds
Disadvantages of Lines of Credit
- Variable interest rate and fluctuating payments
- Very easy to overspend
- Usually hard to qualify since you need a good to exceptional credit rating and an acceptable debt-to-income ratio
- May need to secure with an asset
- Pay interest on what you borrow from the day you withdraw money until you pay back the full balance.
Personal Loans
Personal loans provide you with a lump sum of money that you can use for one-time expenses. Examples include buying a major item, paying for a wedding, or taking a vacation.
However, one difference between a loan and a line of credit is that personal loans have fixed interest rates. This means your payments remain the same throughout the length of your loan. You also know precisely when you will pay off your personal loan if you make timely payments.
Personal loans can be obtained from banks, credit unions, and online lenders, but terms and qualification requirements can vary drastically.
Common Uses of Personal Loans
- Consolidating high interest debt
- Dealing with an emergency
- Financing a large purchase
- Paying for fixed price repairs
Advantages of Personal Loans
- Funds in one lump sum
- Predictable payments
- Fixed repayment timeline
- Set interest rate
- Some lenders focus on stable income, not credit
- Can usually borrow without collateral
Disadvantages of Personal Loans
- Credit score may affect interest rate offered
- Lender may use hard credit inquiry which lowers credit score
- Must pay full payment every time (no interest only option)
- Some lenders charge high fees
- Some lenders penalize early repayment
- May need to borrow again if you don’t borrow enough
Additional Factors to Consider
Besides the factors mentioned above, you will also need to consider what each lender offers you. Interest rates on both lines of credit and personal loans vary greatly. Sometimes the most important factor is your credit score, but not always.
Some lenders consider many factors, with your steady income being the most important. In this case, a lender may not even run a credit check on you if they feel your income can support the loan amount. Consequently, you may be able to get a personal installment loan, even if you have bad credit.
Additionally, each lender determines the maximum amount they’ll offer you. This amount is usually based on your income and your debt. A lower limit line of credit or personal loan are usually easier to get since they are lower risk for lenders. If you need to borrow a large amount of money, you will almost certainly need to have good to excellent credit. Alternatively, you will pay more interest.
Finally, you should carefully consider whether you have the self-control to handle the readily available ongoing money a line of credit provides. You must repay what you borrow, plus interest. However, this form of credit is very easy to abuse, which can lead to a large debt very quickly.
Conversely, personal loans offer the reassurance that you are more likely to pay off your debt. Every payment pays a portion towards interest and a portion towards the principal outstanding. You can’t increase your available credit either, so you limit your risk.
Furthermore, if you fulfill your loan obligations you could potentially enjoy better terms if you ever need to borrow again. Timely repayment may also mean more borrowing options and an easier process.
Deciding Which is Right for You
Both personal loans and lines of credit allow you to borrow money, but they function in different ways. No matter which you choose, you may want to start by reviewing your free credit reports for errors that could negatively affect you.
A personal loan offers a lump sum and has a fixed interest rate and regular payments. Nonetheless, personal loans can vary greatly. We suggest you familiarize yourself with common personal loan terms so you understand what each one offers.
Furthermore, the timeframe for getting money from a personal loan can vary greatly between lenders. Some allow you to get cash fast, while others have a complicated process and take a long time to release funds.
You will also want to make certain the lender does not charge you unnecessary fees. For instance, some charge an origination fee for setting up your account, which is actually an administrative cost they should absorb.
Additionally, some personal loans are closed. If you want to pay more than your scheduled payments, the lender penalizes you. Fortunately, a good lender offers an open personal loan which is penalty-free. Pay extra at any time to shorten your loan term.
On the other hand, lines of credit can be a good solution, if you can qualify. Generally, you must have good to excellent credit and qualifying takes time. If you manage to get a line of credit, you only pay interest initially, but your interest rate may be higher than what you could get through a personal loan.
However, debt can amass quickly when you choose a line of credit, unless you are a very disciplined borrower. Once again, we suggest you read the fine print so you thoroughly understand how a particular line of credit works before you commit.
The Bottom Line on Lines of Credit vs Personal Loans
Do your homework and don’t rush into a decision. If you want to try for a line of credit , realize the lender will almost certainly run a credit check on you which involves a hard inquiry. Hard inquiries lower your credit score by up to 12 points and stay on your credit report for up to 2 years.
Conversely, you may be able to apply for a personal loan without impacting your credit score. Choose a lender that uses a pre-approval process. In this case, they use a soft credit inquiry to get an overview of your financial position. They also consider other factors before they give you their decision, which may improve your likelihood of approval.
Fortunately, FlexMoney may be your solution. We offer Missouri personal loans of up to $2,000, with 12 months to repay. All we ask for is proof of your steady source of recurring income and an active account with an American bank or credit union. We also make the process simple and fast so you may be able to get your cash advance loan as early as today.