What's the difference between a line of credit and a personal loan?
Monday, 13 May 2019
People need to borrow money for many reasons so banks offer multiple lending options to best match customers' needs.
Consider these scenarios:
- You want to replace several appliances in your kitchen. But you need a lump sum, or loan, to cover the total amount of the one-time purchase.
- You are completely remodeling your bathroom and will have ongoing — and sometimes unexpected — expenses throughout the project. Having on-demand access to cash via a line of credit makes more sense in this situation.
Those situations capture the primary difference between a personal loan and line of credit and some of the reasons why you may consider one versus the other.
What are personal loans?
Personal loans are typically unsecured, and for this reason are sometimes referred to as "signature" loans because they are guaranteed by the borrower's signature. The borrower receives the loan in a lump sum and makes monthly payments until all principal, interest, and fees are paid. The length of the loan and monthly payments are agreed upon up front and will not change during the term of the loan.
Some common uses include debt consolidation, major purchases, or medical expenses. But personal loans can be used for almost any purpose.
The primary benefit of a personal loan is its predictability — you borrow a set amount, at a set interest rate, and make set monthly payments for a predetermined number of years. This allows you to budget more effectively because your payment won't change.
Personal loans are ideal when you know the amount you will need up front. For example, when you know how much you need to pay off your credit cards and consolidate your debt.
What is a line of credit?
With a line of credit, instead of receiving a lump sum, you are approved for a credit limit. Then you are able to access funds — typically through a card or checks — whenever you need money. You can get funds at any time, in any amount, up to your credit limit.
Your monthly payments are based on your outstanding balance, or the amount of your line you have used. If you've borrowed only $500, your payments will be lower; your payments will be higher if your balance is $9,000.
Unlike loans, when you make payments on your line, you free up credit. If you borrow $5,000 of a $10,000 line, and then make a payment of $2,500, you would have approximately $7,500 in available credit.
The details vary by lender, but some lines have variable interest rates, which means the rate can change during the term of the line. Obviously, a change in interest rate would also result in a change in your monthly payment.
Lines of credit can be beneficial for open-ended borrowing needs, like a home remodel or possibly long-term travel when you would need ongoing access to an undetermined amount of cash. Some people have personal lines to pay for unexpected expenses so they do not have to deplete savings.
The primary benefit is the flexibility to borrow what you need when you need it, and also to have access to more credit as you pay your balance down. With the flexibility, however, comes some uncertainty as your payment will be different based on your balance and current interest rate.
Lines of credit can be useful for any expense that could be ongoing, such as college tuition, medical expenses, travel, or home improvement projects. But, just like a personal loan, you are free to use the funds however you choose.
As always, it's a good idea to discuss options with a trusted and well-qualified financial consultant to determine what is best for your situation.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
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