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Personal loans are sometimes called signature loans. They get this name due to the fact that if you qualify, you can receive the loan with just your signature. Because the loan is unsecured, you don’t have to put up any assets or collateral, such as a home or vehicle, to secure financing.
Lines of credit, on the other hand, behave like credit card accounts. You can borrow, pay down your balance and access your available credit line again and again. Like a personal loan, you may be able to qualify for an unsecured personal line of credit with just your signature. However, if you secure your line of credit with an asset, you may receive a better interest rate.
1. Loan and line of credit are two different ways of
borrowing from a lender for personal or business use.
2. A loan is a lump sum amount of money that is for one time use whereas a line of credit is an access to a preset amount of money that can be borrowed from multiple times.
3. Interest is charged on the loan immediately irrespective of when the money is used whereas in line of credit, interest is charged once money is borrowed.
4. Loans are for specific purpose whereas a line of credit can be used for any purpose.
5. The interest rate on loans is generally lower than those on a line of credit.
While personal loans and lines of credit offer similar borrowing options in some ways, they are set up differently. From how they accrue interest to how a borrower repays them, these credit options diverge on several important features.
The biggest difference between a personal loan and line of credit is how the borrowed funds are paid out.
With a personal loan, the amount borrowed is set and paid out once in a large sum. The loan holder gets all the money upfront. Often, lenders have a minimum loan amount you must borrow, so smaller loans can be harder to get.
A line of credit, however, is revolving credit. Instead of borrowing money all at once, a line of credit allows the account holder to take out money as it’s needed. The line of credit will have a credit limit, and the borrower can take out as much or as little money as needed, up to that limit.
Figuring out how much you can borrow will depend on a variety of factors, such as your income, your credit and the maximum amount of money a lender is willing to issue. As mentioned above, when you take out a personal loan, you receive your full loan amount in one lump sum. On a line of credit, you can borrow up to your account limit. However, provided your account remains in good standing, you can make payments to reduce your balance and then borrow back up to your account limit again, as needed.
Both personal loans and lines of credit charge interest on borrowed funds, but lines of credit usually have higher interest rates than those offered on personal loans. This can make them a more costly credit option.
Interest rates on lines of credit are determined almost exclusively by the creditworthiness and income of the borrower. The rates on lines of credit are also often variable, so a lender can raise them after the money has been borrowed.
A personal loan might also have a variable rate, but it is more common to have a fixed rate that does not change throughout the life of the loan. Personal loan interest rates are typically lower than those offered on lines of credit.
Many factors can affect personal loan rates, including the length of the loan and even the amount borrowed. This gives the borrower more options to lower their interest rate than they might have with a line of credit.
Another factor to consider when deciding on a personal loan versus a line of credit is how repayment is set up.
A personal loan has a clear, straightforward repayment system. The borrower makes regular payments (usually monthly) for a set repayment term.
With a personal loan, monthly payments are set at the beginning of the loan. The balance and interest earned on the loan are calculated, and then it’s divided over monthly payments set to completely pay off the personal loan over the chosen repayment period.
Payments for a line of credit, however, are not set up for paying off the credit within a certain time frame. Lenders might have different formulas to determine monthly payments, but the system is often similar to how credit card minimum payments are decided.
You can use a personal loan for a variety of reasons. The freedom to use the money you borrow as you see fit (for the most part) is one of the features that makes personal loans attractive to so many people.
There are also several potential benefits to using a personal loan over other types of financing when you need to borrow money. These include:
Lines of credit represent a flexible borrowing option that can be helpful if you don’t know in advance how much money you’ll need to finance a particular project. Examples of times you might want to use a personal line of credit include:
People with variable incomes may benefit from lines of credit as well, to help them cover expenses during gaps in income.
Some of the benefits of using a personal line of credit when you need to borrow money include: