Personal Loan vs Line of Credit: Which is Best for You
Personal loans have grown in popularity over the years as more and more consumers tap into them to finance major life purchases or simply to consolidate existing debt. But a personal loan isn’t the only way to access finance. A line of credit account also offers borrowing options for consumers looking for cash to finance various expenses. We break down what a personal loan is compared to a line of credit and how to choose the right option for your financial situation.
What is a personal loan?
A personal loan is a fixed, lump-sum loan that borrowers can use to cover personal expenses, including major life events or unexpected costs. These can range from emergency costs such as medical bills to financing renovations on a property. The funds are paid out as a lump sum, and the borrower repays in installments, usually at a fixed interest rate and in fixed monthly payments. You can obtain personal loans through banks, credit unions and other lenders online or in person.
Personal loans – both secured and unsecured – are popular among borrowers who want some predictability and stability in their repayments because lenders typically offer them at a fixed rate.
What can personal loans be used for?
A personal loan can give you quick access to cash, especially in a financial emergency or when you need to make a significant purchase. A few examples of uses for personal loans can include:
- Educational costs: While education costs can be covered through student loans, they often do not cover all the expenses. For those who have additional school-related costs, some lenders provide personal loans for educational expenses such as a laptop or research materials. You can also use personal loans for nontraditional education options, like coding bootcamps.
- Funeral costs: Burial costs can be pricey, and some family members may be willing to spend a little more for the service. A personal loan can be used for expenses that go toward providing a proper farewell to a loved one.
- Home improvement costs: Whether you are remodeling your kitchen, bathroom, backyard or adding a room, a personal loan for home improvements can provide a source of financing if you don’t have the savings needed to cover the expense. Making home improvement updates can add value to the home and potentially increase its ability to sell.
- Large personal expenses: Some events can stretch personal savings, and when it’s time to dip into credit, a personal loan can be a cost-effective option. Think of events such as weddings, milestone birthdays, holiday spending and vacations.
- Debt consolidation: There are some instances where debt consolidation makes sense. For instance, if you have high-interest loans with a significant repayment term and the opportunity to pay a much lower interest rate, you can use a personal loan for debt consolidation.
- Medical costs: The cost of medical care can be expensive, even if you have insurance coverage. Whether you are opting for elective cosmetic surgery or need to pay for a necessary procedure, medical loans can be a source of financing to help you afford the treatments you need.
A personal loan can be used for nearly any purpose, and can be a reliable source of funding as long as you are able to afford the payments.
Secured vs. Unsecured Personal Loans
Personal loans fall into two categories, secured and unsecured.
- Secured: A secured personal loan is when a lender requires collateral. This usually happens when the borrower needs a significant loan amount or has poor credit. Since there is a collateral attached to the loan, secured personal loans may carry lower rates than unsecured loans.
- Unsecured: Unsecured personal loans are offered without collateral behind the loan. These are typically for borrowers with good credit. However, they are often more expensive in terms of interest rates and costs, as the lender carries the risk. Factors such as your profile with the lender and credit score might affect your loan amount and rate.
What is a personal line of credit?
A line of credit is a revolving loan that gives you access to funds as you need them. It works like a credit card in that a borrower is approved for a set amount, but you only use what you need. When you have an open line of credit, the funds are available to you again when you pay off the balance.
Banks and credit unions provide these loans, offering secured and unsecured options. The credit limit is preset, and you can use it throughout the draw period, which can go up to 15 years. Depending on your loan terms, you may be required to make minimum payments during the draw period, or pay off a lump-sum balloon payment when the repayment period kicks in.
How a Line of Credit Can Be Used
A personal line of credit comes in handy when you need continuous access to funds but aren’t sure what the final amount will be. A line of credit can be helpful in a number of situations, such as:
- Ongoing renovations: A line of credit can make sense for those with consistent renovation costs but aren’t sure about the budget. While you have access to a set amount of funds, you only pay for the amount you use so you don’t have to overborrow a loan.
- Ongoing medical expenses: Some medical costs are hard to predict, and applying for a lump sum might not work out. For those who need access to cash to fund ongoing medical care and treaments, a line of credit may be an option.
- Large cash deposits: While credit cards are usually people’s first option to pay for things, some vendors may not accept large deposits via credit cards and may require an electronic payment instead. Think large deposits for weddings or special events. A line of credit can be tapped for such expenses.
- Living expenses: People with equity in their homes may be able to tap into a line of credit to help with everyday living expenses. This funding option can be helpful for those in between jobs or waiting for their retirement benefits to kick in