Table Of Content
Personal loans and lines of credit are ways of borrowing from lenders.
When you borrow a loan, the lender sets a non-revolving credit limit. As a result, you can only access the funds once and then make the repayments until the loan is repaid in full.
On the contrary, with a line of credit, you receive a set credit limit and make regular payments that include the principal amount and accrued interest. You have continuous access to the line of credit as long as it is active.
The approval of both personal loans and lines of credit depends on your credit rating, financial history, and relationship with the lender.
Lines of Credit or Personal Loan? Main Differences
Before deciding on whether to apply for a personal loan or lines of credit, there are considerations that you need to make.
-
How They Work
A line of credit is a flexible loan that allows you to access a limited amount of money as needed and repay over a prespecified period. You are charged interest, and the financial institution must approve you.
The interest rate varies, making it difficult to predict the total cost of the money you borrow. Lines of credit are not meant to finance one-time purchases but can be used to purchase items for which a bank may not underwrite a loan.
Due to the nature of lines of credit, they are used in financing projects where you are unsure of the funds needed to complete them.
On the contrary, personal loans work by giving a lump sum of cash up front, and you are required to make fixed monthly payments throughout the loan term.
In personal loans, the money is distributed in a lump sum and generally used for one-time expenses. You make repayments of the principal amount and accrued interest every month. The interest is not taxable. The installment will be the same because of the fixed interest rates and repayment periods.
-
Repayment Options
When you borrow a personal loan, you repay the loan amount and a fixed interest in fixed monthly installments.
On the contrary, the interest charged on lines of credit varies over time. In most cases, lines of credit tend to have higher interest rates than loans, but if you have a high credit score, you can get lower interest rates.
Interest accumulation in lines of credit begins after you take out funds against the credit line. Lines of credit affect credit scores and reports much faster.
-
Credit Effect
When you take a personal loan, it can affect your credit score in different ways.
It may affect your score in the short term and make it hard to get an additional loan before a new loan is repaid. This is because a new loan increases your outstanding debt and increases your number of debts.
However, when you repay your loan promptly, it improves your score.
Credit bureaus track personal lines of credit as revolving credit. Your maximum limit and balance affect your credit utilization.
Your credit report reflects your payment history of the line of credit, which can affect your credit score negatively or positively depending on how you manage the account.
A line of credit affects your line of credit in different ways; for example, a long-standing line of credit adds to the length of your credit history.
-
Interest Rates and Fees
Both personal loans and lines of credit charge interest on the money borrowed.
Personal loans have fixed interest rates, while lines of credit have variable ones. Moreover, lines of credit have higher interest rates because they have a higher risk.
The lender may charge loan origination fees when you borrow a personal loan. Also, a lender may charge you a prepayment fee if you pay off the loan before the end of the loan term.
On the other hand, you do not pay a prepayment fee for lines of credit, but you pay other fees that come with specific lines of credit—for example, an annual fee during the draw period.
-
Requirements
There are different baseline requirements for personal loans and lines of credit.
For a line of credit, you need to have a good credit history, a higher credit score, and a reliable source of income. Collateral is not required for a personal line of credit, but having the security can help.
Lenders evaluate your debt-to-income ratio, credit history, and income when you apply for a personal loan. Lenders will require you to pledge your assets as collateral if you apply for a secured personal loan.
Which Is Better for Consolidating Debt?
It can be difficult to track payments and balances on all your outstanding debts, especially if you have many loans. Consolidating your debts into a single loan can help streamline your finances.
Pros And Cons Of Debt Consolidation Loans
Although some lenders provide debt consolidation loans, you can consolidate your loans using a personal loan.
Pros | Cons |
|---|---|
One Monthly Payment | High Interest Rates |
Improves Your Credit Score | Encourages More Spending |
- One Monthly Payment
When you use a personal loan for debt consolidation, you only worry about one monthly installment.
- Improves Your Credit Score
Consolidating debt using personal loans can boost your credit score by increasing your available credit
- High Interest Rates
Although personal loans usually have lower interest rates than credit cards, the rates can be higher when you have a poor rating.
- Encourages More Spending
You may be encouraged to borrow more when consolidating your debts with a personal loan.
Pros And Cons Of Line Of Credit
On the other hand, you can use lines of credit to consolidate your debts. There are different pros and cons of consolidating your debts using lines of credit.
Below are the pros of using lines of credit to consolidate your debts.
Pros | Cons |
|---|---|
Flexibility | Overborrowing |
Lower Interest Rates | Fees |
Repayment Terms |
- Flexibility
Lines of credit have minimum monthly payments that provide great flexibility.
- Lower Interest Rates
You enjoy low-interest rates when you consolidate your loans using lines of credit.
- Repayment Terms
Lines of credit give you freedom, and you can pay it off at your own pace.
- Overborrowing
Consolidating loans with lines of credit makes it difficult to clear the debts if you are not disciplined.
- Fees
The interest rate and other fees can make consolidating debts using lines of credit expensive.
Which Is Better for a Large Purchase?
When you are making a large purchase, there are a few financing options that you can explore. You can use a personal loan, line of credit, or credit card.
The different options have their pros and cons. Below are the pros of using a personal loan for a large purchase.
- You can budget easily. Personal loans have fixed interest rates making it possible to know your monthly payments. This makes it easier to take a large loan amount and budget for it.
- Flexible repayment schedules. Large purchases require large loan amounts that you can repay conveniently. Personal loans have longer repayment periods of up to 84 months, and you can repay your large loan amount within the period.
As much as there are pros to using personal loans to make a large purchase, there are some drawbacks, including:
- Can lead to payment of paying more interest. Large purchase requires large loan amounts that mostly have long repayment periods. Although interest rates for personal loans are lower, they can be high if the repayment period is spread over a long period.
- Causes damage to your score. When you use a personal loan to make a large purchase, you can damage your score if you fail to repay the loan or make late payments. This could make it difficult to borrow money in the future.
- High Fees. Some lenders charge origination fees when you borrow personal loans. The amount increases when the loan amount is higher. Therefore, when you borrow a large loan amount to make a large purchase, the origination fees increase leading to an increase in the overall cost of the loan.
Which Is Better for Building Credit?
Building credit is tricky, and getting a loan or credit card becomes difficult if you do not have a credit history. A personal loan can help you build your credit if you use it responsibly.
You can build your credit using different types of loans, such as lines of credit and personal loans.
Pros And Cons Of Building Credit With Personal Loans
Below are the pros and cons of using a personal loan to build your credit.
Pros | Cons |
|---|---|
Clearing Other Debts | Some Lenders Don't Report To Bureaus |
Prompt Repayments | Cycle Of Debt |
Delayed Payments Hurt Your Credit |
- Clearing Other Debts
Personal loans have lower interest rates, and you can use the loan to clear your debts.
The acquired loans can help lower your financial burden and improve your credit score.
- Prompt Repayments
When you borrow a personal loan, you have to repay it in monthly installments.
You can improve your credit history and score when you make timely repayments.
- Some Lenders Don't Report To Bureaus
Some lenders do not report personal loans; if you are not careful, you can borrow a loan and make timely payments without any reflection on your credit report.
- Risky
Such loans can force you into a cycle of debt that can hurt your credit score.
- Delayed Payments Hurt Your Credit
If you cannot repay your loan on time, your lender will report your default to the bureaus.
Pros And Cons Of Building Credit With Line Of Credit
Below are the pros and cons of using a personal loan to build your credit.
Pros | Cons |
|---|---|
Low-interest rates | High chances of missing payments |
Flexible repayment schedule | High chances of misuse |
- Low-interest rates
Low interest rates translate to low interest paid. This reduces the cost of the loan making it easier to repay and improve your score.
- Flexible repayment schedule
The repayment schedule of lines f credit is nor prescheduled and the interest rate is variable. This provides flexibility that make it easy to make repayments. Repaying a line of credit improves your credit score.
- High chances of missing payments
They are expensive when the interest is high, and you may fail to make payments on time, thereby affecting your credit score
- High chances of misuse
Lines of credit have revolving funds that increase the possibility of misuse. Misuse of lines of credit can adversely affect your credit score.
FAQs
What Is the Difference Between a Consolidation Loan and a Personal Loan?
A debt consolidation loan is a type of personal loan, which means it's dedicated to a specific purpose – to help you pay off a lump sum of debt.
Can Personal Loans Be Consolidated?
Yes, personal loans can be consolidated. You can use a personal loan to pay off multiple debts by using the funds to pay off every individual loan.
When you consolidate your finances, you streamline your finances. However, it cannot fix your underlying challenges.
What Is the Major Difference Between Lines of Credit and Personal Loans?
Both lines of credit and personal loans allow you to borrow cash, but they have different functions.
A personal loan provides a lump sum of money with fixed monthly repayments, while a line of credit gives you ongoing access to money.
